Why do so many BFM aspirants lose confidence the moment they hear the word Basel?
Why does a topic that is so logical appear so complex in the exam hall?
The issue lies not in the syllabus, but in the approach. Most candidates try to memorize ratios and definitions without understanding the purpose behind capital regulation. As a result, numericals and case studies become confusing.
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Basel III is the backbone of modern banking stability. It explains why banks fail, how losses are absorbed, and how regulators protect depositors. From a BFM perspective, it is one of the most scoring topics because it consistently delivers both conceptual and numerical questions.
This article explains Basel III in an exam-oriented, banker-friendly manner, focusing on logic, structure, and application. It is ideal for CAIIB BFM aspirants, bankers preparing for promotions, and anyone aiming to convert Basel III into a high-scoring area.
Before we dive in, watch this video for a complete breakdown:
Basel III: Meaning and Background
Basel III is issued by the Basel Committee on Banking Supervision to strengthen banks after global financial crises exposed weaknesses such as excessive leverage and inadequate capital buffers.
Basel III focuses on:
- Improving quality of capital
- Increasing minimum capital levels
- Enhancing banks’ loss-absorbing capacity
- Strengthening supervision and disclosure
In simple terms, Basel III ensures that banks remain solvent even during severe financial stress.
The Three Pillars of Basel III
Pillar 1: Minimum Capital Requirement
Pillar 1 answers a fundamental question: How much capital must a bank maintain against risk?
Capital is required against:
- Credit Risk
- Market Risk
- Operational Risk
Capital is maintained on Risk Weighted Assets (RWA), not on total assets. Higher risk attracts higher capital.
Pillar 2: Supervisory Review Process (SRP)
Pillar 2 ensures that risks not captured under Pillar 1 are adequately addressed.
- ICAAP: Internal Capital Adequacy Assessment Process
- SREP: Supervisory Review and Evaluation Process
RBI can require additional capital if a bank’s risk profile warrants it.
Pillar 3: Market Discipline
Pillar 3 promotes transparency through disclosures related to capital, risk exposure, and risk management practices.
Capital Adequacy Ratio (CRAR)
Formula:
CRAR = (Tier 1 Capital + Tier 2 Capital) ÷ Total RWA × 100
Minimum Capital Requirements
India (RBI):
- CRAR: 9%
- Capital Conservation Buffer (CCB): 2.5%
- Total: 11.5%
Global Basel Norm:
- CRAR: 8%
- CCB: 2.5%
- Total: 10.5%
Exam Tip: If country is not specified, assume an Indian bank.
Credit Risk Approaches Under Basel III
Standardised Approach
Under this approach, RBI prescribes fixed risk weights.
- Cash with RBI – 0%
- Interbank exposure – 20%
- Corporate loans – 100%
Internal Rating Based (IRB) Approach
Capital is calculated using four parameters:
- PD: Probability of Default
- LGD: Loss Given Default
- EAD: Exposure at Default
- M: Maturity
Foundation IRB: Bank estimates PD; regulator provides others.
Advanced IRB: Bank estimates all four parameters.
Tier 1 and Tier 2 Capital Structure
Tier 1 Capital (Going Concern Capital)
Tier 1 capital absorbs losses while the bank is operational.
- Common Equity Tier 1 (CET1)
- Additional Tier 1 (AT1)
Tier 2 Capital (Gone Concern Capital)
Tier 2 capital absorbs losses during liquidation and is supplementary in nature.
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Capital Conservation Buffer (CCB)
- Mandatory buffer
- 2.5% of RWA
- Maintained entirely from CET1
Banks breaching CCB face restrictions on dividend distribution.
Components of Common Equity Tier 1 (CET1)
CET1 consists of 10 components:
- Paid-up equity capital
- Statutory reserves
- Disclosed free reserves
- Capital reserves
- Share premium (equity only)
- Balance in P&L account (previous year)
- Current year profits (NPA growth ≤ 25% QoQ)
- Revaluation reserves (45% eligible)
- Foreign currency translation reserves (75% eligible)
- Deferred tax assets
Excluded: Authorised capital and preference shares.
Practical Exam Strategy for Basel III
- Memorize minimum ratios and thresholds
- Understand India vs global Basel differences
- Focus on CET1 components and exclusions
- Practice CRAR and RWA numericals
Basel III alone can fetch 15–20 marks if prepared properly.
Conclusion
Basel III is about understanding banking stability, not rote learning. Once the logic of capital and risk becomes clear, the chapter becomes intuitive.
Key Takeaways:
- Three pillars form the regulatory framework
- CET1 is the backbone of capital
- India follows stricter capital norms
- CET1 components and CRAR are exam favorites
Use this article as a revision guide along with the video. Apply concepts while solving numericals and case studies to maximize your score.
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