Basel Norms in Banking

Internationally, bank risk management and capital adequacy practices are guided by the Basel Accords, a set of frameworks developed by the Basel Committee on Banking Supervision (BCBS). These accords (Basel I, II, III, and the so-called Basel IV) progressively tightened capital requirements and introduced standards for risk management, in response to the evolving financial landscape and crises. Below we outline each Basel norm and their key features, along with India’s approach to implementing them.

Basel I – Capital Adequacy Basics

Basel I, introduced in 1988, was the first international accord on bank capital. Its primary focus was credit risk and ensuring banks held sufficient capital against loans and other credit exposures.

The hallmark of Basel I was the establishment of a minimum Capital Adequacy Ratio – banks were required to hold capital equal to at least 8% of their risk-weighted assets (RWA). This ratio (also known as CRAR) means, for example, if a bank has ₹100 of risk-adjusted assets, it must have at least ₹8 in capital (equity + qualifying reserves).

Assets were categorized into broad risk buckets with fixed risk weights: e.g. sovereign bonds were given 0% weight, well-rated corporate loans 100%, etc., to calculate RWA. Basel I also defined Tier 1 and Tier 2 capital – Tier 1 being core equity capital and Tier 2 supplementary capital – and required at least half of the 8% be Tier 1. By 1992, G-10 countries had enforced Basel I, and eventually 100+ countries adopted these norms.

The Basel I accord was a landmark in creating a level playing field, but it was relatively simplistic. It did not differentiate risk within broad categories (e.g., all corporate loans were 100% risk-weight regardless of credit quality) and initially addressed only credit risk (a 1996 amendment added market risk capital for trading activities).

India adopted Basel I in 1992, ahead of many peers, and mandated banks to maintain a minimum CRAR of 8% (RBI, in fact, set a slightly higher 9% norm for Indian banks). Basel I greatly strengthened bank capital globally – by ensuring banks had a basic loss-absorbing buffer – but its simplicity also left some gaps, which led to the next accord.

Basel II – Three Pillars and Risk Sensitivity

Basel II was released in 2004 as a more refined framework that introduced greater risk sensitivity and a holistic approach to bank risks. It is structured around Three Pillars:

Pillar 1: Minimum Capital Requirements

• Basel II kept the overall capital ratio at 8% of RWA but made the calculation of RWA more risk-sensitive. It expanded the types of risks covered: in addition to credit risk, operational risk (risk of loss from failures in internal processes, people, systems) was introduced with its own capital charge, and market risk measures were refined.
• Banks were allowed to use different approaches to calculate risk weights: for credit risk, either a Standardized Approach (relying on external credit ratings of borrowers) or Internal Ratings-Based (IRB) approaches (where sophisticated banks use their own models to estimate credit risk components, subject to regulator approval).
• Similarly, for operational risk, methods ranged from a basic indicator approach to advanced measurement approaches using internal loss data. The aim was to align capital more closely with the actual risk of each exposure – higher risk assets should consume more capital, lower risk ones less.

Pillar 2: Supervisory Review Process

• This pillar recognized that one-size capital rules might not cover all risks. It required banks to have an Internal Capital Adequacy Assessment Process (ICAAP) to evaluate all risks in their business (including those not fully captured in Pillar 1, like interest rate risk in banking book, concentration risk, etc.) and determine adequate capital for themselves. Regulators then review each bank’s overall risk profile and capital adequacy under Pillar 2.
• Essentially, Pillar 2 gives supervisors the flexibility to demand higher capital or corrective action if they feel Pillar 1 calculations understate the bank’s risk. It formalized the dialogue between banks and regulators on risk management.

Pillar 3: Market Discipline

• This pillar introduced mandatory public disclosures of key risk and capital information to enhance transparency. Banks had to disclose their capital structure, risk exposures, risk assessment processes, and capital adequacy ratios, etc.
• The idea is that informed stakeholders (investors, analysts, depositors) will exert market discipline on banks to manage risk prudently. Greater transparency also helps comparability among banks.

Overall, Basel II brought a more complex but comprehensive approach. By using credit ratings and internal models, it made capital requirements more risk-sensitive than Basel I. For example, under Basel II’s standardized approach, a AAA-rated corporate loan might get a 20% risk weight (thus needing far less capital than under Basel I’s flat 100%), whereas a B-rated loan might carry 150% weight, reflecting its higher risk. However, Basel II’s reliance on ratings and models had drawbacks: it assumed risk assessments (by rating agencies or banks’ own models) were reliable, an assumption that was tested during the 2008 global financial crisis. India implemented Basel II gradually from 2007 to 2009 – all commercial banks shifted to the standardized approaches for credit and operational risk by March 2009. Indian regulators did not immediately allow advanced internal models for credit risk (most Indian banks continued with standardized approaches), which somewhat shielded them from model-risk issues during the crisis.

Basel III – Post-Crisis Reforms (Capital Buffers, Liquidity, Leverage)

In response to the 2007–08 financial crisis, the Basel Committee introduced Basel III in 2010–2011, representing a major overhaul to strengthen bank resilience. Basel III recognized that many banks before the crisis were undercapitalized, over-leveraged, and had inadequate liquidity. Key Basel III measures include:

Higher and Better Capital

• Basel III raised the quality and quantity of capital. Common Equity Tier 1 (CET1), the purest form of capital (equity capital and retained earnings), was set at a minimum 4.5% of RWA (up from 2% in Basel II).
• The total minimum capital (including Tier 1 and Tier 2) remained 8%, but with new buffers on top. A Capital Conservation Buffer (CCB) of 2.5% of RWA (in the form of CET1) was introduced, to be built up in normal times and drawn down in stress. Effectively, banks need 10.5% total capital (of which at least 7% CET1) in normal conditions – if they dip into the buffer, automatic constraints on dividends and bonuses kick in to rebuild capital.
• Additionally, a Countercyclical Buffer (0–2.5% CET1) can be imposed by regulators during credit booms to curb excess lending. Global systemically important banks (G-SIBs) have to hold an extra surcharge as well (notably, some large Indian banks categorized as domestic systemically important also have a small additional buffer).

Leverage Ratio

• To constrain excessive leverage (debt reliance) that risk-weighted ratios might not reveal, Basel III introduced a simple, non-risk-based Leverage Ratio. It requires Tier-1 capital to be at least 3% of total exposure (assets and certain off-balance items).
• This backstop ensures even if a bank’s assets are low-risk weighted, it still holds a minimum capital to total assets. In practice, many jurisdictions (including India) set a slightly higher leverage ratio; e.g. RBI mandates 4% for most banks, 3.5% for select ones, to maintain a cushion above Basel’s floor.

Liquidity Standards

• Basel III for the first time introduced global liquidity requirements. The Liquidity Coverage Ratio (LCR) mandates that a bank hold sufficient High-Quality Liquid Assets (HQLA) to cover its total net cash outflows for 30 days under a stress scenario (i.e. an LCR of 100% or more). This ensures banks can survive short-term liquidity crunches (like sudden deposit withdrawals or drying up of funding markets).
• The Net Stable Funding Ratio (NSFR) complements this by requiring banks to maintain a stable funding profile over a one-year horizon – in essence, to back long-term assets with an adequate amount of long-term funding (equity, long-term bonds, stable deposits). Both ratios discourage over-reliance on short-term wholesale funding which evaporated quickly during the crisis.

Other Risk Coverage Enhancements

• Basel III strengthened capital requirements for counterparty credit risk (e.g. derivatives exposures) and introduced a new Credit Valuation Adjustment (CVA) capital charge to cover risk of losses from deterioration in creditworthiness of derivative counterparties.
• It also bolstered market risk frameworks (later refined under “Basel 2.5” and the Fundamental Review of the Trading Book). However, many of these technical points were part of the later Basel final reforms.

In effect, Basel III demanded banks hold more common equity, build buffers for rainy days, limit their leverage, and maintain liquidity reserves – all to fortify banks against shocks. Implementation was phased: most standards were to be in place by 2019 (though the CCB and NSFR were phased gradually, and some timelines extended).

India adopted Basel III starting April 2013, and today Indian banks maintain a minimum CRAR of 9% plus CCB 2.5% (total 11.5%), CET1 minimum 8% (5.5% + buffer), and have fully implemented LCR and NSFR. In fact, the RBI delayed the last tranche of the CCB during COVID-19, finally achieving the full 2.5% CCB by October 2021. Thanks to Basel III, as of 2025 banks globally are much better capitalized – for instance, many had CET1 ratios well above 12-13% – and hold ample liquidity, which proved crucial during the pandemic and other stress episodes.

Basel IV – Final Revisions and Changes from Basel III

“Basel IV” is an informal term for the final set of Basel III post-crisis reforms announced in December 2017 (with some elements in 2019). While the Basel Committee does not call it “Basel IV” (as they consider it part of Basel III), the changes are significant enough that industry observers use the term. Basel IV’s goal is to “restore credibility in the calculation of risk-weighted assets (RWA) and improve comparability of capital ratios” across banks. It addresses the variability in RWA results under Basel II/III (where banks using internal models could show much lower RWA for similar exposures, making capital ratios hard to compare).

Key Basel IV changes and differences from Basel III include:

Revised Standardized Approaches

• The frameworks for standardized credit risk and operational risk were overhauled to make them more risk-sensitive and robust. For credit risk, Basel IV refined risk weightings – for example, differentiating residential mortgages by loan-to-value bands, introducing specific treatment for commercial real estate and specialized lending, and reducing reliance on external ratings by providing more risk drivers.
• It also set stricter criteria for when banks can use internal models (e.g. disallowing advanced models for certain asset classes like equities, which must now use standardized risk weights). For operational risk, Basel IV eliminated internal model approaches (AMA) and introduced a single Standardized Measurement Approach which bases capital on a combination of a bank’s income and historic loss experience. This makes op-risk capital simpler and comparable.

Constraints on Internal Models

• Basel IV responded to the concern that some large banks’ internal models were underestimating risks. It imposed input floors and modeling constraints. For instance, in credit risk IRB models, it set minimum values for certain parameters (like loss given default for unsecured loans cannot be too low).
• In operational risk, as noted, internal models were removed entirely. The intent is to limit unwarranted capital reduction via aggressive modeling.

Output Floor

• Perhaps the most impactful change is the introduction of an “output floor”. This means that regardless of banks’ internal model calculations, their total RWA cannot be lower than 72.5% of the RWA computed by the standardized approaches. In other words, if a bank’s internal models say it needs only ₹100 of RWA (hypothetically) but the standard approach yields ₹150, the bank must use at least 72.5% of ₹150 = ₹108.75 as its RWA.
• This floor, to be phased in over time (starting 50% and rising to 72.5% by 2028), ensures a minimum level of capital requirement and improves comparability between model banks and non-model banks. It effectively places a check on extreme RWA optimization by sophisticated banks.

Leverage Ratio Buffer for G-SIBs

• Basel IV added a slight twist to leverage ratio for the largest banks: G-SIBs have to maintain an extra leverage buffer (50% of their G-SIB capital surcharge) on top of the 3% base leverage ratio. This further limits leverage in systemically important banks.

Other Revisions

• Basel IV also adjusted the Credit Valuation Adjustment (CVA) risk framework (to better capture derivative credit spread risks), and refined market risk rules (though a separate Fundamental Review of the Trading Book was already underway).

The net effect of these changes is that some banks, especially those that benefitted from very low risk weights via internal models, will see higher RWA under Basel IV and thus need more capital. Estimates suggested significant increases in RWA for certain portfolios like trading books or low-default asset classes, hence the long phase-in to mitigate impact. Basel IV implementation was initially slated to start in 2022, but was delayed (due to COVID-19) to 2023, with full phase-in by 2028.

As of 2025, jurisdictions like the EU and UK plan to implement these final reforms from 2025 onward, and U.S. regulators have proposed rules to begin in 2025 as well.

India’s Roadmap for Basel Implementation

India has proactively adopted Basel norms, often with more conservative tweaks. Basel I was implemented by 1999 (with a 9% capital ratio vs. Basel’s 8%). Basel II was fully in place by March 2009 for all commercial banks (India primarily used the standardized approaches). Basel III was phased in from 2013 to 2019; by March 2019 Indian banks met the 8% Tier 1 and 11.5% total capital (including full CCB) – though the last 0.625% of CCB was delayed to 2020 and then to Oct 2021 due to the pandemic. Indian regulators also implemented LCR (phased 2015–2019) and NSFR (effective Oct 2021) and set a slightly tougher leverage ratio (4% for most banks).

Now, RBI is gearing up for the Basel III final reforms (Basel IV). In fact, in October 2025, RBI announced plans to implement revised Basel III capital norms for banks from April 1, 2027. Draft guidelines on the revised standardised approach for credit risk were issued in October 2025 and for operational risk in June 2023. These closely follow the Basel IV templates – e.g. more granular risk weights for real estate loans, treatments for unrated exposures, etc., as described in RBI’s drafts. This timeline means Indian banks have a couple of years to adjust, and from 2027 the new rules should come into effect (notably slightly behind the major global banks’ schedule).