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Risk Management in Banking and Insurance · Credit Risk Management

Basel Norms for Credit Risk Capital: Standardised and IRB

Updated 11 October 2026 · Fact-checked

Basel norms require a bank to hold minimum capital against credit risk. You multiply each exposure by a risk weight to get risk-weighted assets (RWA), add them up, and divide eligible capital by total RWA. This gives the capital adequacy ratio (CRAR), which must meet the regulatory minimum.

Understand Basel Norms for Credit Risk Capital

A bank lends public money. If borrowers default, losses must be absorbed by the bank's own capital, not by depositors. Basel norms set how much capital a bank must hold against the risk it takes.

Capital is not measured against raw loan amounts. A loan to a government is safer than an unsecured loan to a weak company. So each exposure gets a risk weight. Exposure × risk weight = risk-weighted asset (RWA). Capital is then compared with total RWA, not with total assets.

Basel II rests on three pillars. Pillar 1 is minimum capital for credit, market and operational risk. Pillar 2 is the supervisory review: the bank assesses its own capital needs (ICAAP) and the supervisor checks them. Pillar 3 is market discipline through public disclosure.

For credit risk under Pillar 1, Basel II offers two routes. The standardised approach uses fixed risk weights set by the regulator, often linked to external credit ratings of the borrower. The internal ratings-based (IRB) approach lets an approved bank use its own estimates of PD, LGD and EAD to compute risk weights. The foundation IRB approach uses own PD only; the advanced IRB approach uses own PD, LGD and EAD.

Basel III did not replace the RWA idea. It raised the quality and quantity of capital: more common equity, a capital conservation buffer, a countercyclical buffer, and a leverage ratio. Check the current RBI minimum ratios and risk weights in your study material before the exam, as RBI may revise them.

Key rules to remember

Risk-weighted asset (funded exposure)
RWA = Exposure (net of eligible provisions/collateral, where allowed) × Risk weight
Use the exposure value the question gives. Apply the risk weight as a percentage.
Off-balance sheet exposure
Credit equivalent = Notional amount × Credit conversion factor (CCF); RWA = Credit equivalent × Risk weight
Convert first, then apply the counterparty's risk weight.
Capital adequacy ratio (CRAR)
CRAR = Eligible capital ÷ Total RWA × 100
Total RWA should include credit, market and operational risk RWA when given.
Tier 1 ratio
Tier 1 ratio = Tier 1 capital ÷ Total RWA × 100
Tier 1 = Common Equity Tier 1 + Additional Tier 1.
Minimum capital required
Required capital = Total RWA × Minimum CRAR %
Compare with actual capital to find surplus or shortfall.
Capital for operational/market risk to RWA
RWA equivalent = Capital charge × (100 ÷ Minimum CRAR %)
Use the minimum ratio the question states, for example ×11.11 at 9%.
IRB inputs
Expected loss = PD × LGD × EAD
IRB risk weights are driven by PD, LGD and EAD (and maturity). Foundation: own PD. Advanced: own PD, LGD, EAD.

How to solve Basel Norms for Credit Risk Capital questions

Use this order for any numerical or theory question on Basel credit risk capital.

  1. 1Read what is asked: RWA, CRAR, surplus or shortfall, or a comparison of approaches.
  2. 2List each exposure with its amount, borrower type and any rating, collateral or guarantee.
  3. 3Convert off-balance sheet items using the credit conversion factor given.
  4. 4Assign the risk weight stated in the question to each item. Use the given weights, not memory.
  5. 5Compute RWA for each item and add them to get total RWA. Add market and operational RWA if given.
  6. 6Identify eligible capital: Tier 1 plus Tier 2, after any limits or deductions stated.
  7. 7Compute CRAR = capital ÷ total RWA × 100 and compare with the minimum stated.
  8. 8State the conclusion in one line: compliant or not, and the surplus or shortfall in rupees.

Quickest way: Table-and-compare method

When to use it: Use for 2-mark MCQs and short CRAR sums when the question gives risk weights.

  1. Write exposure × weight beside each item in one line.
  2. Sum the RWA once and check the arithmetic.
  3. Divide capital by RWA; for MCQs, test each option against the figure you get.
  4. For shortfall, compute RWA × minimum % and subtract actual capital.

Common mistakes in Basel Norms for Credit Risk Capital

  • Dividing capital by total assets instead of RWA

    It feels like a normal ratio of capital to assets.

    Fix: CRAR always has RWA in the denominator. Weight every asset first.

  • Applying the risk weight to the notional of an off-balance sheet item

    Students skip the conversion factor.

    Fix: Multiply by the CCF first, then by the counterparty risk weight.

  • Mixing up standardised and IRB approaches

    Both use ratings-related ideas.

    Fix: Standardised: regulator-set weights. IRB: bank's own PD (and LGD, EAD in advanced), with supervisory approval.

  • Listing Basel II pillars wrongly or confusing them with Basel III

    Both frameworks keep similar vocabulary.

    Fix: Remember Pillar 1 capital, Pillar 2 review, Pillar 3 disclosure. Basel III strengthened capital quality and added buffers and leverage ratio.

  • Ignoring market and operational risk RWA when they are given

    The chapter is about credit risk, so students stop early.

    Fix: If the question gives them, add them to the denominator for total CRAR.

  • Using a remembered risk weight that differs from the question

    Weights change by rating and RBI revisions.

    Fix: Always use the weights in the question. In theory answers, say weights depend on the borrower and rating.

Worked examples

Example 1

A bank has these exposures: government securities ₹200 crore (risk weight 0%), loans to highly rated corporates ₹300 crore (risk weight 20%), retail loans ₹400 crore (risk weight 75%), and unrated corporate loans ₹100 crore (risk weight 100%). Its eligible capital is ₹95 crore. Compute the CRAR.

Show the solution
  1. Government securities: 200 × 0% = ₹0.
  2. Rated corporates: 300 × 20% = ₹60 crore.
  3. Retail: 400 × 75% = ₹300 crore.
  4. Unrated corporates: 100 × 100% = ₹100 crore.
  5. Total RWA = 0 + 60 + 300 + 100 = ₹460 crore.
  6. CRAR = 95 ÷ 460 × 100 = 20.65% (approximately).

Answer: Total RWA is ₹460 crore and CRAR is about 20.65%.

Example 2

A bank has credit RWA of ₹700 crore, market risk RWA of ₹100 crore and operational risk RWA of ₹200 crore. Eligible capital is ₹85 crore. Minimum required CRAR is 9%. Find the CRAR and the shortfall or surplus.

Show the solution
  1. Total RWA = 700 + 100 + 200 = ₹1,000 crore.
  2. CRAR = 85 ÷ 1,000 × 100 = 8.5%.
  3. Required capital = 1,000 × 9% = ₹90 crore.
  4. Shortfall = 90 − 85 = ₹5 crore.
  5. Since 8.5% is below 9%, the bank does not meet the minimum.

Answer: CRAR is 8.5%, below the 9% minimum, with a capital shortfall of ₹5 crore.

Exam tips

  • Numericals usually supply the risk weights and capital. Show the RWA line by line to earn step marks.
  • For MCQs, compute RWA first; most wrong options come from using total assets or skipping the CCF.
  • In theory answers, compare standardised and IRB in a short two-column style list: who sets weights, inputs used, approval needed.
  • Always end a CRAR sum with a one-line compliance conclusion and the rupee surplus or shortfall.
  • Revise the current RBI minimum ratios and buffers from your study material, as they can change.

Practice questions from Credit Risk Management

Basel Norms for Credit Risk Capital in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Basel Norms for Credit Risk Capital: frequently asked questions

What is the difference between standardised and IRB approach?

In the standardised approach, the regulator fixes risk weights, often by external rating and exposure type. In the IRB approach, an approved bank uses its own estimates of PD, and in the advanced version LGD and EAD, to derive risk weights.

How do I calculate the capital adequacy ratio?

Add up all risk-weighted assets, then divide eligible capital (Tier 1 plus Tier 2) by total RWA and multiply by 100. Compare the result with the minimum required ratio.

What are the three pillars of Basel II?

Pillar 1 is minimum capital for credit, market and operational risk. Pillar 2 is supervisory review of the bank's own capital assessment. Pillar 3 is market discipline through disclosure.

What did Basel III change for credit risk capital?

It improved the quality and quantity of capital, with more weight on common equity. It also added a capital conservation buffer, a countercyclical buffer and a leverage ratio. The RWA method still applies.