Banking Regulation: NPAs and Basel Norms

The RBI's monetary policy tools (repo, CRR, SLR, the MPC) get most of the attention, but a separate, equally testable layer of its work is regulating banks themselves: how much capital they must hold, what counts as a bad loan, how a bad loan gets resolved, and how much credit must reach priority sectors. This ground is covered here, deliberately kept distinct from monetary policy tools and money market instruments, both already covered elsewhere on this site.

Who regulates a bank, and under what law

The RBI's power to license, inspect, and discipline banks comes from the Banking Regulation Act, 1949, separate from the RBI Act, 1934, which governs the RBI's own monetary functions. Under this Act the RBI grants banking licences, sets branch expansion norms, inspects a bank's books, approves or removes its directors, and in an extreme case places a bank under moratorium or directs its amalgamation with a stronger bank, the tool used in several recent bank rescues. Co-operative banks sit in an unusual dual-regulation position: registration and management fall under state Registrars of Co-operative Societies, while banking functions (licensing, capital adequacy) fall under the RBI, a split UPSC likes to test as a "who regulates what" question.

The structure of Indian banking: who owns what

Before the rules, it helps to fix who they apply to. Public Sector Banks (PSBs), in which the Government holds a majority stake, have gone through heavy consolidation: 27 in 2017, down to 12 today. The State Bank of India absorbed its five associate banks (State Bank of Bikaner and Jaipur, Hyderabad, Mysore, Patiala, and Travancore) along with the Bharatiya Mahila Bank on 1 April 2017. Bank of Baroda absorbed Dena Bank and Vijaya Bank in 2019. Then the Union Cabinet approved a mega-consolidation of ten more PSBs into four, effective 1 April 2020: Oriental Bank of Commerce and United Bank of India into Punjab National Bank, Syndicate Bank into Canara Bank, Andhra Bank and Corporation Bank into Union Bank of India, and Allahabad Bank into Indian Bank. What is left today is SBI plus 11 nationalised banks: the six enlarged entities above, plus Bank of India, Bank of Maharashtra, Central Bank of India, Indian Overseas Bank, Punjab and Sind Bank, and UCO Bank. Private Sector Banks carry no government stake requirement at all, licensed by the RBI under the Banking Regulation Act like any other bank. Foreign banks operate in India either as branches of the parent bank or, under an RBI scheme, as locally incorporated Wholly Owned Subsidiaries, a structure that carries its own capitalisation and board-composition conditions distinct from a branch.

Regional Rural Banks (RRBs), set up under the Regional Rural Banks Act, 1976 for rural and semi-urban lending, have a distinctive tripartite ownership no other bank type shares: the Central Government (50%), a sponsor bank, usually a PSB that also provides the RRB's initial staffing and technical support (35%), and the concerned State Government (15%). Under the 2015 amendment to the Act, an RRB may now raise capital from other sources too, but the combined Centre-plus-sponsor-bank stake cannot drop below 51%, and the Centre must consult the state government before its own holding falls below 15%. This ownership pattern is the key thing that separates RRBs from the Small Finance Banks and Payments Banks covered below: SFBs and Payments Banks are independently licensed, privately capitalised entities with no state or sponsor-bank shareholding built into their structure at all.

What makes a loan an NPA, and how it gets classified

An advance becomes a Non-Performing Asset (NPA) when interest or principal remains overdue for more than 90 days (a shorter, seasonal rule applies to agricultural loans: one crop season overdue for long duration crops, two for short duration crops). Once flagged, an NPA moves through classification categories based on how long it stays bad: sub-standard (an NPA for up to 12 months), doubtful (beyond 12 months), and loss asset (virtually uncollectible, even if not yet formally written off). Provisioning rises through this ladder, from a flat rate on sub-standard assets up to 100% on loss assets, so a bank sets aside more real money against a loan the longer it stays bad.

Gross NPA versus net NPA: a distinction worth holding onto

Two different NPA numbers get quoted, and mixing them up is an easy trap. Gross NPA is the straight total of every sub-standard, doubtful, and loss asset on a bank's books, before any adjustment. Net NPA, per the RBI's own Master Circular on Income Recognition and Asset Classification, is gross NPA minus the provisions the bank has already set aside against those bad loans (plus a few smaller technical deductions, such as interest-suspense balances and claims received but not yet adjusted). A bank that has provisioned heavily against its bad loans can carry a high gross NPA figure while its net NPA, the portion still genuinely eating into its own capital, is much lower. This is exactly why the PCA framework above uses the net NPA ratio, not the gross figure, to trigger its thresholds: net NPA reflects what is actually left uncovered, which is the number that threatens a bank's solvency. As a sense of scale, PSBs' gross NPA ratio peaked at roughly 14.6% around 2018, at the height of the post-Asset Quality Review recognition drive covered below; net NPA at the same banks ran well below that, because heavy provisioning was already underway.

Catching trouble early: the PCA framework

The Prompt Corrective Action (PCA) framework is the RBI's early-warning mechanism, triggered when a bank breaches set thresholds on three fronts: capital (CRAR or CET1 below the regulatory minimum by defined margins), asset quality (net NPA ratio crossing 6%, then 9%, then 12%), and leverage (the Tier 1 leverage ratio below its floor). A bank under PCA faces curbs on dividends, branch expansion, and management pay, meant to force correction before it actually fails. Several public sector banks were under PCA through the late 2010s before exiting it.

The depositor's own backstop: DICGC

PCA is preventive, aimed at the bank before it collapses. If a bank does fail, or is placed under an RBI moratorium or All Inclusive Directions, the depositor's own protection comes from the Deposit Insurance and Credit Guarantee Corporation (DICGC), a wholly owned subsidiary of the RBI set up under the DICGC Act, 1961. Every depositor is insured up to ₹5 lakh per depositor per bank, covering principal and accrued interest together, across every deposit an individual holds in the same right and the same capacity at that bank, whether savings, current, fixed, or recurring. This limit was raised from an older ₹1 lakh with effect from 4 February 2020. Coverage is wide, running across commercial banks (including foreign bank branches, local area banks, and RRBs) and co-operative banks, but it excludes deposits of the Centre or state governments, inter-bank deposits, deposits received outside India, and deposits with primary co-operative societies, which are not covered at all. A 2021 amendment to the Act (Section 18A) further requires DICGC to make an interim payment up to the insured limit within 90 days once a bank is placed under restrictive RBI directions, rather than making a depositor wait out a prolonged resolution, a reform that followed real hardship cases where depositors were locked out of their own money for months. Keep DICGC distinct from PCA and from the resolution routes below: PCA tries to stop a bank failing, DICGC pays out if it does, and SARFAESI/IBC recover value from the borrower who caused the loss in the first place.

Resolving an NPA once it exists

Two legal routes handle a bad loan once classification alone isn't enough. The SARFAESI Act, 2002 lets banks seize and sell a defaulter's secured collateral directly, without a civil court, a major speed advantage over ordinary debt recovery, though it does not apply to agricultural land. The Insolvency and Bankruptcy Code (IBC), 2016 took a more systemic approach: a time-bound resolution process before the National Company Law Tribunal (NCLT), aiming to revive a defaulting company under a new plan or liquidate it, on a fixed clock. The RBI's own June 2019 "Prudential Framework for Resolution of Stressed Assets" sits alongside these: once a borrower defaults, lenders get a defined review period to agree a resolution plan before the loan is referred onward, replacing an earlier, more rigid February 2018 circular that the Supreme Court struck down for exceeding the RBI's statutory authority under Section 35AA of the Banking Regulation Act.

Why PSBs needed recapitalising

Resolving bad loans through SARFAESI or the IBC still leaves a bank having absorbed a real loss. The RBI's 2015 Asset Quality Review (AQR) forced banks to stop understating stress and recognise loans as NPAs transparently, which is exactly why the headline NPA figures jumped so sharply after 2015: PSBs' gross NPAs rose from about ₹2.79 lakh crore as on 31 March 2015 to a peak of about ₹8.96 lakh crore as on 31 March 2018, per the RBI's own data placed before Parliament. A bank absorbing losses at that scale cannot keep lending and stay within Basel III's capital floors at the same time unless fresh capital arrives from somewhere. This is the "Recapitalisation" step in the Government's own 4R strategy (Recognition, Resolution, Recapitalisation, Reform), sitting alongside AQR (recognition) and the IBC (resolution) already covered above. The government's main instrument was recapitalisation bonds: government securities issued specifically to PSBs, which the bank then holds as an investment while the government uses the same transaction to inject fresh equity capital into that bank, a route that does not require an immediate cash outflow from the government's own budget the way a straight equity cheque would. Between FY16 and FY19, PSBs were recapitalised to the extent of about ₹3.12 lakh crore, split between roughly ₹2.46 lakh crore infused by the Government and about ₹0.66 lakh crore PSBs raised themselves from the market. This is the fiscal cost the NPA crisis actually carried, and it is why recapitalisation, Basel III compliance, and the NPA classification and resolution machinery above are one connected story rather than four separate topics.

Basel III: how much capital a bank must actually hold

Basel III sets the minimum capital a bank must hold against its risk-weighted assets, implemented in India in phases from 1 April 2013. The numbers, verified against the RBI's own Master Circular: Common Equity Tier 1 (CET1) at least 5.5% of risk-weighted assets, Tier 1 capital (CET1 plus Additional Tier 1) at least 7%, and Total Capital (CRAR), Tier 1 plus Tier 2, at least 9%. Banks must also hold a Capital Conservation Buffer (CCB) of 2.5%, purely in Common Equity, on top of the minimum CET1, bringing the fully loaded minimum Total Capital plus CCB to 11.5%. Keep these numbers attached to the right layer, CET1 versus Tier 1 versus total CRAR, since a statement question often swaps one figure for another.

Priority sector lending and financial inclusion

Beyond capital and NPA rules, the RBI directs where a share of bank credit must flow. Under the RBI's own Master Directions on Priority Sector Lending (effective 1 April 2025), domestic commercial banks and foreign banks with 20 or more branches must lend 40% of Adjusted Net Bank Credit (ANBC) to the priority sector, with sub-targets of 18% to agriculture (14% reserved for non-corporate farmers), 7.5% to micro enterprises, and 12% to weaker sections. Regional Rural Banks carry a steeper 75% overall target; Small Finance Banks and urban co-operative banks were both set at 60% under the 2025 Directions, the SFB target having been reduced from its earlier 75% to align it with urban co-operative banks. Alongside this, the RBI has licensed dedicated Small Finance Banks (since 2015, for underserved MSMEs and small borrowers) and Payments Banks (accept deposits, enable payments, but cannot lend). The Pradhan Mantri MUDRA Yojana (PMMY), launched in 2015, extends collateral-free loans to small non-corporate businesses under three tiers, Shishu, Kishor, and Tarun, graded by loan size. Governance reform sits alongside this: the Banks Board Bureau (2016, on the P.J. Nayak Committee's recommendation, to professionalise PSB appointments) was succeeded by the Financial Services Institution Bureau (FSIB) in 2022.

A recent reform: the Banking Laws (Amendment) Act, 2025

The regulatory framework above is not frozen. The Banking Laws (Amendment) Act, 2025, notified on 15 April 2025, makes 19 amendments across five laws at once, the RBI Act 1934, the Banking Regulation Act 1949, the SBI Act 1955, and the Banking Companies (Acquisition and Transfer of Undertakings) Acts of 1970 and 1980, aimed at strengthening bank governance and depositor protection. Its provisions came into force in two phases. From 1 August 2025: the threshold defining "substantial interest" in a bank, the shareholding level that triggers RBI scrutiny of a director or promoter, was raised from ₹5 lakh to ₹2 crore, a figure that had not moved since 1968; co-operative bank directors (other than the chairperson and whole-time directors) got their maximum tenure extended from 8 to 10 years, aligning with the 97th Constitutional Amendment; and PSBs were empowered to pay statutory auditors' remuneration directly and to transfer unclaimed shares, dividends, and bond redemption amounts to the Investor Education and Protection Fund. From 1 November 2025: depositors gained the right to multiple nominations, up to four persons, either simultaneously (each assigned a specified percentage of the deposit) or successively (the next nominee taking over only on the earlier nominee's death), replacing the old rule of a single nominee per account.

Why this matters for the exam

Keep several boundaries firm. First, the Banking Regulation Act (licensing and supervision) is a different statute from the RBI Act (monetary policy), even though the same institution administers both. Second, SARFAESI and the IBC solve the same problem, a defaulted loan, through different routes: SARFAESI acts on collateral directly, the IBC acts on the borrowing company as a whole through a tribunal. Third, the Basel III numbers are graded, CET1 at 5.5%, Tier 1 at 7%, total CRAR at 9%, plus a 2.5% buffer, and UPSC likes testing whether you can match a stated percentage to its correct layer rather than treating "capital adequacy" as one number.

Two more boundaries matter now that the fuller picture is in view. Fourth, gross NPA and net NPA are not interchangeable: a question stating a bank's "NPA ratio" without saying which one is being deliberately loose, and the PCA framework's own trigger is specifically the net figure. Fifth, do not confuse the RRB's tripartite ownership (Centre 50%, sponsor bank 35%, state government 15%, a government-linked joint structure) with Small Finance Banks and Payments Banks, which are independently licensed private entities with no such shareholding split. And keep DICGC separate from everything else in this chapter: it is not a resolution mechanism and not a regulator, it is the depositor's own insurance cover, capped at ₹5 lakh per depositor per bank, paid out when a bank actually fails rather than when it merely breaches a ratio.

Quick revision points

• Banking Regulation Act, 1949 governs bank licensing and supervision; the RBI Act, 1934 governs the RBI's own monetary role.
• PSBs: 27 in 2017, now 12, after SBI absorbed its 5 associate banks plus Bharatiya Mahila Bank (2017), Bank of Baroda absorbed Dena and Vijaya Bank (2019), and 10 more PSBs merged into 4 stronger banks effective 1 April 2020.
• RRBs: tripartite ownership, Centre 50%, sponsor bank 35%, state government 15% (combined Centre plus sponsor bank cannot fall below 51% even if outside capital is raised); distinct from SFBs and Payments Banks, which have no such government/sponsor-bank shareholding.
• NPA: overdue more than 90 days (seasonal rules for agriculture); classified sub-standard (up to 12 months), doubtful (beyond 12 months), or loss asset.
• Gross NPA = total bad loans before adjustment; net NPA = gross NPA minus provisions already held. PCA's asset-quality trigger uses the net figure.
• PCA framework: triggers on capital, net NPA ratio (6%, 9%, 12% thresholds), and leverage breaches.
• DICGC: wholly owned RBI subsidiary, insures deposits up to ₹5 lakh per depositor per bank (raised from ₹1 lakh, effective 4 February 2020); a 2021 amendment requires an interim payout within 90 days once a bank is placed under RBI restrictions.
• SARFAESI Act, 2002 (collateral seizure, no court) and the IBC, 2016 (time-bound NCLT resolution) are the two main NPA-resolution routes.
• Recapitalisation: PSBs recapitalised by about ₹3.12 lakh crore (FY16-FY19), mainly through recapitalisation bonds, the "R" in the Government's 4R strategy (Recognition, Resolution, Recapitalisation, Reform).
• Basel III (India, phased from 2013): CET1 at least 5.5%, Tier 1 at least 7%, total CRAR at least 9%, plus a 2.5% Capital Conservation Buffer (11.5% fully loaded).
• PSL target: 40% of ANBC for domestic and larger foreign banks (18% agriculture, 7.5% micro enterprises, 12% weaker sections); 75% for RRBs; Small Finance Banks and urban co-operative banks at 60% (SFBs reduced from 75% under the 2025 Directions).
• MUDRA loans: Shishu, Kishor, Tarun tiers. FSIB (2022) succeeded the Banks Board Bureau (2016) for PSB appointments.
• Banking Laws (Amendment) Act, 2025: "substantial interest" threshold raised from ₹5 lakh to ₹2 crore; co-operative bank director tenure raised from 8 to 10 years; deposit nominations now allow up to 4 nominees.

With the regulatory numbers and the resolution routes in place, test yourself against statement-based questions built around this chapter.