With the release of the final market-risk guidelines on September 21, following the February 2023 draft guidelines and the Investment Portfolio Directions that became effective April 1, 2024, banks can reassess and crystallise their market-risk assessments and capital needs.

Thus, banks are gradually aligning with Basel III standards as they further integrate the ECL framework from April 1, 2027, the Basel 3.1 framework and the new method for computing the capital charge for market risk, both effective April 1, 2027.

As heightened sensitivity to risk management and a focus on aligning capital with risks become core to business models, banks will need to develop a capital optimisation plan before pursuing balanced business growth, so that capital is deployed more effectively.

If a bank adopts a system that prioritises growth across lines of business without measuring inherent risks and their corresponding capital needs, it should seriously review its systems and processes to align with the new regulatory framework's call for prudent capital optimisation.

Implementing the comprehensive Basel 3.1 regulations, effective April 1, 2027, will require more refined, data-driven calculations of capital charges for credit, loan-to-value exposures, credit cards, unsecured exposures, market risk and operational risk. This should help banks reshape the balance sheet's asset-liability mix and harness the full potential of the capital base, as measured by risk-adjusted return on capital, on a sustained basis.

The first line of defence in risk management, which uses risk weights and a risk-based pricing system to assess the implications of business growth, may not fully account for potential risks and capital needs unless systems and processes are well embedded to enable such assessment.

Banks should integrate the proactive evaluation of business growth, risks, risk-based pricing and capital needs into the strategic business planning process to keep risk weights, business growth and the capital-to-risk-weighted assets ratio on track, with no surprises at the end of any accounting period.

In a buoyant economy, with abundant opportunities to structurally align balance-sheet growth, risks and risk-mitigation tools, these areas need stronger reinforcement to better optimise the capital base. Risk management and the capital implications of business growth must be central to balance-sheet management.

Trends in Risk Alignment
Based on the final guidelines for computing market-risk capital charges, risk-weighted assets under the Fundamental Review of the Trading Book are expected to increase capital needs by 15%-20%, depending on market conditions and the composition of banks' trading books at any point in time.

Similarly, the new standardised approach for credit risk applies tighter risk weights to unrated corporates and NBFCs, increasing aggregate credit risk-weighted assets by 5%.

When migrating from the Basic Indicator Approach to the Standardised Measurement Approach for operational risk, which incorporates a bank's actual historical loss experience rather than gross income alone, the estimated minimum regulatory load could increase from the current 8.6% to 18.1% of capital. Cyber risk can be a large contributor.

When assessing the holistic risk-weighted asset load on capital, the share attributable to credit risk may decline from 87% to 84% over the next two years. Market risk may rise from 5% to 5.4%, and the operational-risk load may increase from 8% to 10.5% of the total capital pool. The combined impact of the increase in risk-weighted assets under the revised regulatory guidelines could move the index from 100 to 108, lowering the capital adequacy ratio from the current level of 17.2% to 16.38%.

Drilling Down Into the Impact
The convergence of the Expected Credit Loss framework, Basel 3.1 refinements and the revised market-risk capital framework represents the most significant regulatory overhaul of bank capital in India in over a decade.

The systemic capital requirement and the projected path for the sector's Capital to Risk-Weighted Assets Ratio (CRAR)—currently at 17.2%—could change materially by April 2027.

The ECL framework may require additional provisioning of ₹900 billion-₹1.2 trillion for the banking system, depending on credit growth and which credit-risk components materialise, with expected additional capital needs of ₹180 billion-₹250 billion. Several public- and private-sector banks have already created countercyclical provision buffers and floating provisions that will partially absorb this transition.

Regarding the impact of recalibrating risk weights under the Basel 3.1 framework, banks may require an estimated additional ₹100 billion-₹150 billion, driven primarily by higher risk weights on select unrated corporate exposures, NBFCs and commercial real estate. Since banks in India operate under the Standardised Approach for credit and operational risk rather than advanced internal models, the output-floor impact may not immediately affect domestic lenders.

Similarly, the RBI’s recent Minimum Capital Requirements for Market Risk Directions, 2026, revise the boundary between the Banking Book and the Trading Book, including Held for Trading positions. The changes may require an additional ₹150 billion-₹220 billion of system-wide capital, assuming current market exposures persist. Indian banks hold sovereign debt predominantly under Held to Maturity (HTM), which falls under the Banking Book. Mark-to-market requirements therefore do not apply in the same way, while the capital charge on interest-rate risk is concentrated mainly in active HFT desks and derivative trading portfolios.

Given the new regulations and their impact, the total capital hit during 2027-28 could range from ₹450 billion-₹600 billion, lowering CRAR by 40-55 bps. The cumulative five-year impact may require an additional ₹1.25 trillion-₹1.55 trillion in system capital, lowering CRAR by 110-135 bps.

The Indian banking sector’s aggregate CAR stood at a multi-decade high of 17.2%, with Common Equity Tier 1 (CET1) at 14.1% and Tier 2/AT1 making up the balance. If no further capital is added, CAR may stand at around 16.38%, still sufficient to support the resilience of the banking system.

Way Forward
In an evolving macroeconomic and business ecosystem facing rising geopolitical and geoeconomic risks, historically high asset quality, provision coverage ratio, NIM, ROA and CAR may come under stress.

While the economy's continued resilience and the policy pathway for realising the vision of Viksit Bharat 2047 are well entrenched, banks can benefit from adopting a strategically curated capital optimisation plan. A better alignment of the mix of risks, business composition and capital conservation can unleash the full potential of capital deployment and enhance RAROC.

Line management must be equipped to understand the link between risk-based loan pricing and the risk weights inherent in credit expansion, and their direct connection to CAR, as credit risk continues to dominate banks' risk profiles while they also focus on market and operational risks.