Basel I

Purpose and content of Basel I  standards

Events and circumstances in the 1970’s and 1980’s (increased volatility on financial markets, deregulation, globalization, innovative instruments, debt crises) which resulted in the erosion of the capital base of large banks around the world, motivated the BCBS to create and publish in 1988 the first international agreement on capital requirements for the banks (Basel Capital Accord), known as Basel I. The purpose of Basel I standards was to introduce a uniform way of calculating capital adequacy in order to strengthen financial stability. Basel I defines elements of bank capital, weighting factors for calculating credit risk for balance sheet items (weighted average risk factors: 0%, 20%, 50% and 100%) and credit conversion factors for off-balance items (after which appropriate risk weighting factors are applied), as well as ratio between the capital and total exposure of the bank (balance and off-balance) risk weighted in order to calculate the capital adequacy indicators. The capital adequacy indicator of a bank, calculated in this way, should be at least 8%:

————————————————————————— ≥ 8 %

Advantages and positive effects of implementation of Basel I standards:

  • Substantial increases in capital adequacy ratios of internationally active banks;
  • Relatively simple structure;
  • Worldwide adoption;
  • Increased competitive equality among internationally active banks;
  • Greater discipline in managing capital;
  • A benchmark for assessment by market participants.

Weaknesses of Basel I standards

In spite of advantages and positive effects, weaknesses of Basel I standards eventually became evident:

  • Capital adequacy depends on credit risk, while other risks (e.g. market and operational) are excluded from the analysis; 
  • In credit risk assessment there is no difference between debtors of different credit quality and rating;
  • Emphasis is on book values and not market values; 
  • Inadequate assessment of risks and effects of the use of new financial instruments, as well as risk mitigation techniques.

The most important amendments to Basel I standards

Some of the weaknesses of Basel I, especially those related to market risk, were overbridged by the amendment to recommendations from 1993 and 1996, by means of introducing capital requirements for market risk and a new instrument for the assessment of bank’s market risk – VaR (Value at Risk).

————————————————————————— ≥ 8 %
Risk weighted exposures (credit and market risks)