Basel Norms, NPAs & Risk Management

1When a loan stops performing

A bank's loan book is an asset only while repayments arrive on schedule. RBI's uniform trigger is duration, not intent: interest or principal overdue for more than 90 days reclassifies the account as a Non-Performing Asset (NPA). Until that line is crossed the loan stays standard; once crossed, provisioning and recovery rules tighten even if the borrower later pays.

After the 90-day mark RBI sub-classifies the NPA by how long it has stayed impaired. Up to 12 months in NPA status it is sub-standard; beyond 12 months it becomes doubtful; when recovery is no longer realistic it is tagged loss. The 90-day definition pairs with picking the right grade for a given overdue timeline.

Figure. Overdue past 90 days makes the account an NPA. While in NPA status: up to 12 months is sub-standard, beyond 12 months doubtful, and unrecoverable accounts are loss. Magnitudes are order, not calendar scale.

2Where Basel norms come from

Basel norms are international banking regulations issued by the Basel Committee on Banking Supervision (BCBS). The committee sits at the Bank for International Settlements (BIS) in Basel, Switzerland — the Swiss place name labels the committee's home, not a separate Indian statute. Indian banks meet these standards because the RBI aligns domestic capital and liquidity rules with them.

Three generations of the framework share one agenda and differ in how tightly they bind capital, supervision and disclosure. Basel I put a floor under capital against credit risk. Basel II kept the capital idea and added supervisory review plus market discipline through disclosure. Basel III, written after the 2008 global financial crisis, raised capital quality and quantity and added liquidity and leverage standards on top.

Figure. Basel norms come from the BCBS at the BIS in Basel. Generations tighten from capital floors (I) to three pillars (II) to post-crisis capital, liquidity and leverage (III); the RBI aligns Indian banks to them.

3CRAR and the capital floors

The Capital to Risk-weighted Assets Ratio (CRAR) asks how much capital a bank holds for each unit of risk-weighted assets: \text{CRAR} = \frac{\text{Tier 1 capital} + \text{Tier 2 capital}}{\text{Risk-Weighted Assets}} \times 100. Higher CRAR means a thicker cushion before depositors take losses when risky assets sour.

Basel III's global minimum total CRAR is 8%. The RBI mandates 9% for Indian banks — one percentage point stricter than the Basel floor. On top of the minimum, banks must also hold a Capital Conservation Buffer (CCB) of 2.5%, so the usable capital stack often quoted is the minimum plus that buffer.

Figure. CRAR = (Tier 1 + Tier 2) / risk-weighted assets. Basel's total floor is 8%; RBI mandates 9% for Indian banks, plus a 2.5% Capital Conservation Buffer on top.

4Tier 1 versus Tier 2 capital

CRAR's numerator splits into two tiers with different loss-absorbing jobs. Tier 1 is core capital — equity and disclosed reserves — and absorbs losses on a going-concern basis: the bank is still operating while these instruments take the hit. Tier 2 is supplementary capital and absorbs losses on a gone-concern basis: it cushions creditors after the bank has failed as a going concern.

The discrimination is which tier is 'core' or which absorbs losses while the bank is still alive. Pair going-concern with Tier 1 and gone-concern with Tier 2.

Figure. Tier 1 (equity and disclosed reserves) absorbs losses while the bank is still operating. Tier 2 is supplementary capital for gone-concern loss absorption after failure.

5Basel III liquidity and leverage

Basel III did more than raise the CRAR floor. It introduced the Capital Conservation Buffer, a Leverage Ratio that constrains balance-sheet size relative to capital without risk weights, and two liquidity standards that stop a solvent bank from failing for lack of cash.

The Liquidity Coverage Ratio (LCR) requires enough high-quality liquid assets to survive a stressed 30-day outflow. The Net Stable Funding Ratio (NSFR) looks further out: it requires stable funding to support assets over a one-year horizon. Short-term survival is LCR; structural funding over a year is NSFR.

Figure. LCR stocks enough high-quality liquid assets for a 30-day stress outflow. NSFR requires stable funding over a one-year horizon. The leverage ratio constrains balance-sheet size without risk weights.

How the two liquidity tests differ

1. Ask the horizonIf the stem says a 30-day cash crunch, the ratio in play is LCR; if it says stable funding over a year, it is NSFR.
2. Identify the stockLCR is answered with high-quality liquid assets; NSFR is answered with stable funding sources, not overnight cash alone.
3. Keep leverage separateThe Leverage Ratio sits beside both: it limits on- and off-balance-sheet exposure relative to capital without using risk weights.

6Three risks that need capital

Under Basel norms a bank must hold capital against more than one kind of loss. Credit risk is the chance the borrower defaults on a loan or other exposure. Market risk is the chance prices move against the bank — interest rates, FX, equities or commodities on the trading book. Operational risk covers failures in people, processes or systems, including fraud and external events that disrupt operations.

A missed EMI is credit; a bond portfolio mark-to-market loss is market; a data-centre outage that stops settlements is operational. Each bucket then feeds the risk-weighted assets that sit in the CRAR denominator.

Figure. Capital covers three buckets: credit (borrower default), market (adverse price moves on the trading book), and operational (people, process, systems, fraud). Each feeds risk-weighted assets.

7Recovering and resolving bad loans

Once an account is an NPA, capital rules alone do not get the money back. India relies on two headline statutes for stressed assets. The SARFAESI Act, 2002 lets secured creditors enforce security interest — including taking possession and selling collateral — without a long court decree for every step. The Insolvency and Bankruptcy Code (IBC), 2016 is the broader corporate insolvency and resolution framework that can restructure or liquidate a defaulting borrower under a time-bound process.

Banking-awareness questions usually test the pair of years and the job each law is famous for: SARFAESI for enforcement of security by banks and financial institutions, IBC for insolvency resolution of stressed companies. Do not treat them as synonyms — one is a secured-creditor enforcement toolkit, the other is a full insolvency code.

Figure. SARFAESI (2002) lets secured creditors enforce collateral without a full court decree for every step. IBC (2016) is the time-bound corporate insolvency and resolution code — not a synonym for SARFAESI.

Choosing the recovery frame

1. Identify the toolIf the stem stresses enforcing a mortgage or charged asset without a full trial, think SARFAESI 2002.
2. Identify the processIf the stem stresses corporate insolvency, creditor committees or resolution timelines, think IBC 2016.
3. Keep the years fixedSARFAESI = 2002; IBC = 2016 — swapping the years is the most common trap.