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Basel I

Basel I is the first of the Basel committee's three Basel accords set up. It explains the benefits and limitations of Basel I and the key differences between the Basel accords.

Basel I is the first set of international banking regulations set up by the Basel Committee on Banking Supervision and is a part of Basel accords, including Basel II and Basel III. The accord’s goal was to standardise banking practices all over the world. Basel I mainly focuses on the goal of minimising credit risk. It was released in 1988 to provide a framework for risk management from a bank’s capital adequacy perspective. Its regulations were intended to improve the safety and stability of the bank system worldwide. Basel I is not much in use now, but it is laid out as a framework for Basel II and III. 

Implementation

Basel, I was introduced in 1988, and countries of G10 followed it in 1992. Basel, I regulations improve the financial system’s stability by setting the optimum capital ratio required for international banks. It provided a simplified structure for overseeing credit risk by calculating the percentage of risk weighing of different assets. Banks having an international presence were required to maintain 8% of their risk-weighted assets as cash reserves. Basel, I classified risk-free assets based on risk weight percentage. The following points explain the classification in detail.

  • 0% for assets such as Cash, Government debt, central bank debt, and government organisation debts.
  • 10% for assets such as Central bank debt of countries with high inflation
  • 20% for development bank debts
  • 50% for municipal revenue bonds residential mortgages
  • 100% for corporal debt

 Tier 1 capital refers to fixed capital. It is at least 50% of the total bank’s capital. Tier 2 is short-term capital.

Benefits

Basel, I was the first international instrument for assessing the importance of risk concerning capital. It is a milestone in finance and banking history. Basel, I focused on lessening the credit risk to users, banks, insurance companies, and countries’ economies. It substantially increased the capital ratios of the international banks and improved competitive equity. Basel, I had a simple approach that allowed widespread adoption worldwide. It provided a benchmark for financial evaluation for users of financial information.

Basel II was introduced after some time to remove the disadvantages and improve the Basel I regulations for the banks. Over 100 countries also adopted Basel I regulations after being enforced in G10 countries. Many banks continued to operate under regulations of Basel I structure instead of Basel II, which Basel III later preceded. The best thing about Basel I frameworks is that it provides ongoing adjustments in the banking regulations and practices, creating more protective measures.

Limitations

Basel, I was criticised for many issues. Some of them included limited differentiation of credit risk, which broadly classified RWA into four categories based on an 8% minimum capital ratio. It ignored the different levels of risks associated with different currencies and macroeconomic risks. The capital level charges were set on the same level regardless of the maturity of credit exposure. Basel I did not consider market risk, operational risk, liquidity risks. The assumption of taking an 8% capital ratio did not consider the changing nature of default risk. In this case, a solution that would be helpful was to form an internal credit risk model.

Basel II was introduced to mitigate the problems related to Basel I. The operational risk was negatively viewed, but later, the Basel Committee on banking supervision introduced operation risk management in Basel II. One of the improvements made in Basel II due to the criticisms of Basel I was that it allocated capital to cover operational risks and advocate an operational risk management system. 

The key difference between Basel I, II, and III

The main difference between Basel I, II, and III was the different objectives they were established to achieve. Basel I was formed to explain a minimum capital requirement for the banks. Basel II introduced supervisory responsibilities and further improved the minimum capital requirements. Basel III focused on decreasing the damage done to the economy by the banks which take too much risk. While Basel I only focused on credit risk, Basel II focused on operational, strategic, and reputational risks. Basel III focused on liquidity risks, and the risks focused on Basel II.

Conclusion

Basel I is the oldest of the Basel accord released in 1988 to reduce the risks to consumers, financial institutions, and the economy. Basel II and Basel III preceded this. This article concluded that the Basel I accords is an important accord that is the foundation of subsequent accords. In Basel 1, the Basel committee had negatively defined operations risks while proposing the revision in subsequent accords. Basel II was made to refine the regulations and improve the regulation based on limitations and Basel III improved the regulations of Basel II.