Banking Regulation in India: NPAs, Basel Norms and Financial Inclusion

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.

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.

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.

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.

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 and Small Finance Banks carry a steeper 75% overall target, urban co-operative banks 60%. 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.

Why this matters for the exam

Keep three 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.

Quick revision points

• Banking Regulation Act, 1949 governs bank licensing and supervision; the RBI Act, 1934 governs the RBI's own monetary role.
• NPA: overdue more than 90 days (seasonal rules for agriculture); classified sub-standard (up to 12 months), doubtful (beyond 12 months), or loss asset.
• PCA framework: triggers on capital, net NPA ratio (6%, 9%, 12% thresholds), and leverage breaches.
• SARFAESI Act, 2002 (collateral seizure, no court) and the IBC, 2016 (time-bound NCLT resolution) are the two main NPA-resolution routes.
• 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 and Small Finance Banks.
• MUDRA loans: Shishu, Kishor, Tarun tiers. FSIB (2022) succeeded the Banks Board Bureau (2016) for PSB appointments.

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