More on News -

● The CAFRAL -Centre for Advanced Financial Research and

Learning , a research body set up by the Reserve Bank of India
(RBI), has highlighted a growing risk in bank financing for Non-
Banking Finance Companies (NBFCs)

● It also identified potential dangers in the digital lending landscape.

● It also warned about rising unsecured loans in Indian economy

More On News -

● The Reserve Bank of India decided to increase the risk weight on

the exposure of banks to consumer credit, credit card receivables
and non-banking finance companies.

● Such increase in the risk weight on unsecured loans is a way of

increasing the Capital to Risk-Weighted Assets Ratio (CRAR)
requirement for banks who give loans to NBFCs and other
institutions which later turn into risk assets for bank.
 Types of Loans

Secured Unsecured
Loans Loans

with Loans given

Loans given
collaterals without collaterals

Risk For High Risk for

Low
Banks
Banks
● With rising of such unsecured loans , the financial stability of
economy can be in danger .
Example - Chances of rising NPA, inflation in the economy etc.

● To tackle this issue, RBI has increased Risk Weight on Bank

Exposure
What is Risk Weight on Bank Exposure ?

● It is a method that determines the amount of capital that banks

need to hold against these assets as a buffer to cover potential losses.

● The risk weight assigned to different categories of assets are

different .

For example - More riskier assets have more risk weight

● Hence, if more risk weights are assigned then it increases Bank’s

Risk Weighted Asset(RWA)
 ↑ *
Asset Type Risk Weight
Assigned
Source : RBI Circular
● Based on this , Risk Weighted Asset (RWA) is Calculated for
a financial entity
For Example

Rs 650
Hence
, Risk Weighted Asset = .

for given conditions

● These Risk-weighted assets are used to determine the minimum
capital that banks should hold to reduce the risk of insolvency in
the form of Capital to Risk-Weighted Assets Ratio (CRAR) or
Capital Adequacy Ratio (CAR)
Capital Adequacy Ratio (CAR)

● Also called as capital to risk weighted asset ratio (CRAR)

● It is the ratio of a bank’s capital in relation to its risk weighted

-

assets and current liabilities.

● Capital Adequacy Ratio = (Tier I capital + Tier II capital )v

Risk weighted assets
v
● Higher the capital to risk weighted asset ratio (CRAR), higher is
the safety of bank deposits.
Tier 1 capital:
● It is bank's core capital.
● This capital type can absorb losses without the bank having to
cease operations.
● It includes ordinary share capital, equity capital, audited revenue
reserves, and intangible assets.

Tier 2 capital:
● It refers to a bank's supplementary capital.
● This type of capital can absorb losses in the event of the bank's
liquidation, providing less protection to depositors.
● It includes unaudited reserves, unaudited retained earnings, and
general loss reserves.
According to Basel III Norms, a CAR of 8% is prescribed.
However, in India, the Reserve Bank of India ( RBI ) mandates
a CAR of 9% for scheduled commercial banks, while public
sector banks are required to maintain a CAR of 12%.

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● Hence, with RBI increasing the risk weights (as done by RBI
recently) , the RWA of bank will increase.

● With this rise of RWA , banks need to generate additional capital

to adhere to prescribed figures of CRAR as mandated by RBI.

● It can be achieved by bankers by the process of Recapitalization

( Raising of new capital)

● Investors investing in new capital may demand higher interest

from bankers considering the tightening by RBI.

● The cost of capital will thus increase for bankers.

● This increased Cost of capital will also impact borrowers in
market

● Loans become more expensive and liquidity in market can be

controlled.

Costlier Expensive
High Risk More
Loans to
weights Capital Raising
For Bankers Borrowers

Careful · Decreased demand

· More
of loans
Lending
ex CIBIL Score
·
Inflation Control
.

check
·
NPA Control
BASEL NORMS
FOR
BANKING
Basel Norms for Banking
● Basel, a city in Switzerland which is the headquarter of Bank
for International Settlement (BIS), an international financial
institution.

● BIS fosters co-operation among Central Banks with a common

goal of financial stability and common standards of banking
regulations.

● Basel Committee on Banking Supervision (BCBS)

formulated broad supervisory standards which mainly focuses on
risks to banks and the financial system referred as Basel accord.

● BCBS was established by the Central Bank governors of the

Group of Ten countries in 1974. The BCBS now has 45 members
● India has accepted Basel accords for the banking system.

● The Basel Committee has issued three sets of regulations

which are known as Basel-I, II, and III.
 Basel Norms

The Basel Norms, also known as Basel Accords, are a series

of international banking regulations issued by the Basel
Committee on Banking Supervision (BCBS).

They provide recommendations on banking laws and

regulations with the primary objective of enhancing financial
ur
stability by strengthening regulation, supervision, and
~
practices of banks worldwide
Basel-I

●Introduced in 1988

● It focused almost entirely on credit risk

● It defined capital and structure of risk weights for banks.

● The minimum capital requirement was fixed at 8% of risk

weighted assets (RWA).
Basel-II

● Introduced in 2004 by BCBS.

● More refined version of Basel I

● Three pillars were given by the committee

1. Capital Adequacy Requirements: Banks should maintain a minimum

capital adequacy requirement of 8% of risk assets

2. Supervisory Review: According to this, banks were needed to develop

and use better risk management techniques in monitoring and managing
all the three types of risks that a bank faces that is credit, market and
operational risks.
3. Market Discipline: This needs increased disclosure requirements.
Banks need to mandatorily disclose their CAR, risk exposure, etc to
the central bank.

● Basel II norms in India and overseas are yet to be fully implemented

though India follows these norms.
Basel III:

● Introduced in 2010

● Introduced in response to the financial crisis of 2008.

● Four vital banking parameters that is capital, leverage, funding

and liquidity were taken into account.

● First, a bank needs to calculate its Risk Weighted Asset (RWA)

● Against these RWA, (Universal) Scheduled Commercial Banks
(SCB) must keep -

1. Minimum Capital to Risk Weighted Assets Ratio (CRAR) at 8% or

-

higher

2. “x%” Capital Conversation Buffer (CCB) to absorb losses during

periods of financial and economic stress

3. “y%” Counter Cyclic Capital Buffer (CCCB) which will serves as

an extension to the capital conservation buffer.

4.“z%” Leverage Ratio (LR) against their exposure in various loan

assets from 2015
Leverage Ratio

● The leverage ratio, as defined under Basel-III norms, is Tier-I

capital as a percentage of the bank’s exposures (bank's average
total consolidated assets)

● The framework is designed to capture leverage associated with

both on- and off-balance sheet exposures.

T
-
● The Basel Committee on Banking Supervision (BCBS) has set
the minimum requirement for leverage ratio at 3%.

● In 2019, RBI had mandated a leverage ratio of 3.5% for all the
banks except for the domestic systemically important banks (D-
SIBs), which will have a 4% ratio.

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● Each member country’s Central Bank can prescribe different
range of these ratios depending on their country’s situation.

For example -

According to Basel III Norms, a CAR of 8% is prescribed.

However, in India, the Reserve Bank of India ( RBI ) mandates
a CAR of 9% for scheduled commercial banks, while public
sector banks are required to maintain a CAR of 12%.
 10 +
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-
15
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Basel-III created two liquidity ratios

1. Liquidity Coverage Ratio (LCR)

2. Net Stable Funds Rate (NSFR)

LCR

● It will require banks to hold a buffer of high-quality liquid

assets sufficient to deal with the cash outflows encountered in
an acute short term stress scenario as specified by supervisors.

● LCR ensures banks to maintain High Quality Liquid Assets

·
(HQLAs) to meet 30 days net outgo under stressed conditions.

● This will help in situations of Bank Run

The Net Stable Funds Rate (NSFR)

● It requires banks to maintain a stable funding profile in relation

to their off-balance-sheet assets and activities.

● NSFR requires banks to fund their activities with stable sources

of finance (reliable over the one-year horizon).

● LCR measures short-term (30 days) resilience, and NSFR

measures medium-term (1 year) resilience.