Basel Norms & Risk Management: The Bank's Safety Net
Banks hold your money. But what if the bank itself fails? Enter Basel Norms —the global rulebook that ensures banks have enough "Own Money" to survive a financial earthquake.
Key Takeaways
- Basel Norms are global regulations to strengthen the banking system, named after the city of Basel, Switzerland.
- CAR (Capital Adequacy Ratio) is the "Buffer" a bank must keep. If they lend ₹100, they must keep ₹9 of their own capital aside.
- NPA (Non-Performing Asset) is a loan that has stopped earning interest (Bad Loan). High NPAs = Risk of Bank Failure.
- Tier 1 Capital is the bank's core money (Equity), while Tier 2 is supplementary.
The Earthquake Analogy: Why We Need Rules
Imagine you are building a skyscraper. If you build it on weak soil with cheap materials, a small earthquake will destroy it.
Banks are like skyscrapers. They lend out huge amounts of money. If many borrowers default (an economic earthquake), the bank could collapse.
Basel Norms
are the "Building Codes" that force banks to have a strong foundation (Capital).
The Evolution: Basel I, II, and III
The rules keep getting stricter because financial crises keep happening.
- Basel I (1988): Focused only on Credit Risk (Default risk).
- Basel II (2004): Added Operational Risk (Fraud, Systems failure) and Disclosure requirements.
- Basel III (2010): Introduced after the 2008 Global Financial Crisis. It demands more capital and better quality capital (Liquidity coverage).
The Golden Formula: CAR
Capital Adequacy Ratio (CAR) is the single most important number for a bank's health.
CAR = (Tier 1 Capital + Tier 2 Capital) / Risk Weighted Assets
In India: The RBI requires banks to maintain a minimum CAR of 9% (stricter than the global 8%).
What are "Risk Weighted Assets" (RWA)?
Not all loans are equal. Lending to the Government is safer than lending to a Startup.
If a bank lends ₹100 to the Govt, it needs ₹0 capital.
If it lends ₹100 on a Credit Card (High Risk), it effectively treats it as ₹125 exposure and must keep capital for that.
The Villain: Non-Performing Assets (NPA)
An asset turns into an NPA when the borrower stops paying interest or principal for 90 days .
Why are NPAs dangerous?
1. The bank stops earning income.
2. The bank must set aside profit (Provisioning) to cover the loss, which reduces its capital.
3. If NPAs get too high, the bank fails (e.g., Yes Bank crisis, PMC Bank).
Types of Risk Banks Face
1. Credit Risk
Borrower will not pay back. (Default)
2. Market Risk
Loss due to changes in interest rates or stock prices.
3. Operational Risk
Loss due to failed systems, fraud, or human error.
Is your Bank Healthy?
Don't just look at interest rates. Look at the Net NPA ratio . If it is above 6%, be careful.
Explore Fintech (Next Module)Frequently Asked Questions
Does Basel III apply to all banks? ▼
Yes, RBI mandates all scheduled commercial banks in India to comply with Basel III norms to ensure stability.
What is Tier 1 vs Tier 2 Capital? ▼
Tier 1 is "Core Capital" (Equity shares, retained earnings) - it can absorb losses immediately. Tier 2 is "Supplementary" (Subordinated debt) - less reliable.