BASEL I

Alen Kolic Risk Management in Banking

Banking and Finance
Internatioanal Burch University
 BASEL I
In 1988, the Basel Committee (BCBS) in Basel, Switzerland,
published a set of minimal capital requirements for banks, known
as 1988 BasselAccord or Basel 1
Primary focus on credit risk
Assets of banks were classified and grouped in five categories to
credit risk weights of 0, 10, 20, 50 and up to 100 %
Assets like cash and coins usually have 0 risk weight, while
unsecured loans might have a risk weight of 100%
CAPITAL ADEQUACY RATIO
(CAR)
Expressed as percentage of banks risk weighted credit
exposures
Also known as Capital to Risk Weighted Assets Ratio (CRAR)
Ratio is used to protect depositors and promote the stability
and efficiency of financial systems around the world.
PURPOSE OF BASEL I
Strengthen the stability of international banking system
Set up a fair and a consistent international banking system in
order to decrease competitive inequality among international
banks
Achievment: to set up a minimum risk-based capital adequacy
applying to all banks and governments in the world
BASEL NORMS IN BANKING
SYSTEM
Basel Accord I was established in 1988 and was implemented
by 1992 in India
Over 3 years banks with branches abroad were required to
comply fully by end March 1994 and the other banks were
required to comply by end March 1996
RBI norms on capital adequacy at 9% are more stringent than
Basel Committee stipulation of 8%
Commercial Banks, Cooperative Banks and Reginal rural banks
have different RBI guidelines
PITFALLS OF BASEL I
Limited differentiation of credit risk ( 0%, 20%, 50% and 100%)

Static measure of default risk ( The assumption that a minimum 8% capital ratio is
sufficient to protect banks from failure does not take into account the changing
nature of default risk )
No recognition of term-structure of credit risk ( The capital charges are set at the
same level regardless of the maturity of a credit exposure )
Simplified calculation of potential future counterparty risk ( The current capital
requirements ignore the different level of risks associated with different currencies
and macroeconomic risk. In other words, it assumes a common market to all actors,
which is not true in reality)
Lack of recognition of portfolio diversification effects ( In reality, the sum of individual
risk exposures is not the same as the risk reduction through portfolio diversification.
Therefore, summing all risks might provide incorrect judgement of risk )
PROBLEMS WITH BASEL I
Regulatory arbitrage was rampant
Basel I gave banks the ability to control the amount of capital
they required by shifting between on-balance sheet assets
with different weights, and by securitising assets and shifting
them off balance sheet a form of disintermediation
Banks quickly accumulated capital well in excess of the
regulatory minimum and capital requirements, which, in effect,
had no constraining impact on bank risk taking.
CONCLUSION
Basel I Milestone in Finance and Banking History
It launched the trend toward increasing risk modeling research
However, its over-simplified calculations, and classifications
have simultaneously called for its dissappearance, paving the
way for the Basel II Capital Accord
It led to further agreements as the symbol of the continuous
refinement of risk and capital
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