What Is Basel I?
Basel I is a set of international banking regulations established by the Basel Committee on Banking Supervision (BCBS). It prescribes minimum capital requirements for financial institutions, with the goal of minimizing credit risk. Under Basel I, banks that operate internationally were required to maintain at least a minimum amount of capital (8%) based on their risk-weighted assets. Basel I is the first of three sets of regulations known individually as Basel I, II, and III, and collectively as the Basel Accords.
- Basel I, the first of three Basel Accords, created a set of rules for banks to follow to mitigate risk.
- Basel I is now considered too limited in scope, but it laid the framework for the subsequent Basel Accords.
- With the advent of Basel I, bank assets were classified according to their level of risk, and banks are required to maintain emergency capital based on that classification.
- Under Basel I, banks were required to keep capital of at least 8% of their determined risk profile on hand.
History of the Basel Committee
The BCBS was founded in 1974 as an international forum where members could cooperate on banking supervision matters. The BCBS says it aims to enhance “financial stability by improving supervisory know-how and the quality of banking supervision worldwide.”1 This is done through regulations known as accords.
Basel I, the committee’s first accord, was issued in 1988 and focused mainly on credit risk by creating a classification system for bank assets.
The BCBS regulations do not have legal force. Members are responsible for implementation in their home countries. Basel I originally called for a minimum ratio of capital to risk-weighted assets of 8%, which was to be implemented by the end of 1992. In September 1993, the BCBS announced that G10 countries‘ banks with material international banking business were meeting the minimum requirements set out in Basel I. According to the BCBS, the minimum capital ratio framework was adopted not only in its member countries but in virtually every other country with active international banks.
Benefits of Basel I
Basel I was developed to mitigate risk to consumers, financial institutions, and the economy at large. Basel II, brought forth some years later, lessened the capital reserve requirements for banks. That came under some criticism, but because Basel II did not supersede Basel I, many banks continued to operate under the original Basel I framework, later supplemented by Basel III addendums.
Perhaps the greatest legacy of Basel I was that it contributed to the ongoing adjustment of banking regulations and best practices, paving the way for further protective measures.
Criticism of Basel I
Basel I has been criticized for hampering bank activity and slowing growth in the overall world economy by making less capital available for lending. Critics on the other side of that argument maintain that the Basel I reforms did not go far enough. Both Basel I and Basel II were faulted for their failure to avert the financial crisis and Great Recession of 2007 to 2009, events that became a catalyst for Basel III.
Basel I was developed to mitigate risk to consumers, financial institutions, and the economy at large.
Requirements for Basel I
The Basel I classification system groups a bank’s assets into five risk categories, labeled with the percentages 0%, 10%, 20%, 50%, and 100%. A bank’s assets are assigned to these categories based on the nature of the debtor.
The 0% risk category consists of cash, central bank and government debt, and any Organisation for Economic Co-operation and Development (OECD) government debt. Public sector debt can be placed in the 0%, 10%, 20%, or 50% category, depending on the debtor.
Development bank debt, OECD bank debt, OECD securities firm debt, non-OECD bank debt (under one year of maturity), non-OECD public sector debt, and cash in collection all fall into the 20% category. The 50% category is for residential mortgages, and the 100% category is represented by private sector debt, non-OECD bank debt (maturity over a year), real estate, plant and equipment, and capital instruments issued at other banks.
The bank must maintain capital (referred to as Tier 1 and Tier 2 capital) equal to at least 8% of its risk-weighted assets. This is meant to ensure that banks hold an adequate amount of capital to meet their obligations. For example, if a bank has risk-weighted assets of $100 million, it is required to maintain capital of at least $8 million. Tier 1 capital is the most liquid type and represents the core funding of the bank, while Tier 2 capital includes less liquid hybrid capital instruments, loan-loss and revaluation reserves, as well as undisclosed reserves.
What Is Basel I?
Basel I is the first of three sets of international banking regulations established by the Basel Committee on Banking Supervision, based in Basel, Switzerland. It has since been supplemented by Basel II and Basel III, the latter of which is still implemented as of 2022.
What Is the Purpose of Basel I?
The purpose of Basel I was to establish an international standard for how much capital banks must keep in reserve in order to meet their obligations. Its regulations were intended to enhance the safety and stability of the banking system worldwide.
How Is Basel I Different From Basel II and Basel III?
Basel I introduced guidelines for how much capital banks must keep in reserve based on the risk level of their assets. Basel II refined those guidelines and added new requirements. Basel III further refined the rules based in part on the lessons learned from the worldwide financial crisis of 2007 to 2009.
The Bottom Line
Basel I was the earliest of the three Basel Accords and introduced capital reserve requirements for banks based on the riskiness of their assets. It has since been supplemented by Basel II and Basel III.