What Is Basel I?

What Is Basel I?

Let me explain Basel I to you directly: it's the first set of international banking regulations put together by the Basel Committee on Banking Supervision (BCBS). This framework sets minimum capital requirements for banks, aiming to cut down on credit risk. If you're a bank operating across borders, Basel I demands you keep at least 8% capital based on your risk-weighted assets. It's the starting point of the three Basel Accords—I, II, and III—which together form the Basel Accords.

Key Takeaways

Here's what you need to grasp about Basel I: as the first Basel Accord, it established rules for banks to follow in order to manage risk effectively. It created the groundwork that later accords built upon. Under this system, we classify bank assets by their risk level, and banks must hold emergency capital accordingly. Specifically, banks need to have at least 8% of their risk profile in capital ready at all times.

History of the Basel Committee

The Basel Committee on Banking Supervision started in 1974 as a forum for international cooperation on banking oversight. Their goal, as they state it, is to boost financial stability by improving supervisory knowledge and banking supervision quality globally. They achieve this through regulations called accords.

Basel I, their first accord from 1988, zeroed in on credit risk with a system to classify bank assets. These BCBS rules aren't legally binding; it's up to member countries to enforce them locally. Originally, Basel I set an 8% minimum capital to risk-weighted assets ratio, to be in place by the end of 1992. By September 1993, the committee reported that banks in G10 countries with significant international operations met these standards. In fact, this framework spread to almost every country with active international banks, not just members.

Benefits of Basel I

Basel I was designed to reduce risks for consumers, banks, and the broader economy. When Basel II came along later, it eased some capital reserve rules, which drew criticism, but since it didn't replace Basel I, many banks stuck with the original setup, eventually adding Basel III elements.

The biggest impact of Basel I, in my view, is how it started the continuous evolution of banking regulations and best practices, setting the stage for more protective measures down the line.

Criticism of Basel I

Critics argue that Basel I restricted bank activities and slowed global economic growth by tying up capital that could have been lent out. On the flip side, others say it didn't go far enough. Both Basel I and II got blamed for not stopping the 2007-2009 financial crisis and Great Recession, which pushed for Basel III.

Another issue is its basic risk-weighting method: it assigns fixed weights to asset types, which can seem arbitrary and not truly capture real risks. For instance, all corporate loans get the same weight, ignoring the varying financial health of borrowers. Plus, it mainly deals with credit risk and overlooks market risk or operational risk, so banks with heavy trading or complex instruments might underreport their capital needs.

Requirements for Basel I

Under Basel I, we group a bank's assets into risk categories: 0%, 10%, 20%, 50%, 100%, and 150%, based on the debtor. The 0% category covers cash, central bank, and government debt—the safest stuff. Public sector debt often goes into 20% or higher, depending on specifics.

Things like development bank debt, OECD bank debt, OECD securities firm debt, short-term non-OECD bank debt, non-OECD public sector debt, and cash in collection fit into 20%. Residential mortgages are at 50%, while private sector debt, long-term non-OECD bank debt, real estate, plant and equipment, and other banks' capital instruments are at 100%. Banks rated below B- externally go to 150%.

You, as a bank, must hold capital—Tier 1 and Tier 2—equal to at least 8% of your risk-weighted assets to cover obligations. For example, with $100 million in risk-weighted assets, you need at least $8 million in capital. Tier 1 is the most liquid, core funding; Tier 2 includes hybrids, loan-loss reserves, revaluation reserves, and undisclosed reserves.

What Is Basel I?

To reiterate, Basel I is the first in a series of three international banking regulations from the Basel Committee in Switzerland. It's been built upon by Basel II and Basel III, with the latter still rolling out as of 2022.

What Is the Purpose of Basel I?

The point of Basel I is to set a global standard for bank capital reserves to ensure they can meet obligations. It aims to make the worldwide banking system safer and more stable.

How Is Basel I Different From Basel II and Basel III?

Basel I set the initial rules for capital reserves based on asset risk. Basel II tweaked those and added more requirements. Basel III refined everything further, drawing from the 2007-2009 crisis lessons.

The Bottom Line

In summary, Basel I kicked off the Basel Accords by requiring banks to hold capital reserves of at least 8% against their asset risks. It focused on credit risk mitigation and has been expanded by Basel II and III.