What is Basel I?
Basel I refers to a set of international banking regulations created by the Basel Committee on Bank Supervision (BCBS), which is based in Basel, Switzerland. The committee defines the minimum capital requirements for financial institutions, with the primary goal of minimizing credit risk. Basel I is the first set of regulations defined by the BCBS and is a part of what is known as the Basel Accords, which now includes Basel II and Basel III. The accords’ essential purpose is to standardize banking practices all over the world.
Bank Asset Classification System
The Bank Asset Classification System classifies a bank’s assets into five risk categories on the basis of a risk percentage: 0%, 10%, 20%, 50%, and 100%. The assets are classified into different categories based on the nature of the debtor, as shown below:
Basel I primarily focuses on credit risk and risk-weighted assets (RWA). It classifies an asset according to the level of risk associated with it. Classifications range from risk-free assets at 0% to risk assessed assets at 100%. The framework requires the minimum capital ratio of capital to RWA for all banks to be at 8%.
Tier 1 capital refers to capital of more permanent nature. It should make up at least 50% of the bank’s total capital base. Tier 2 capital is temporary or fluctuating in nature.
Benefits of Basel I
- Significant increase in Capital Adequacy Ratios of internationally active banks
- Competitive equality among internationally active banks
- Augmented management of capital
- A benchmark for financial evaluation for users of financial information
- Other kinds of risk, such as market risk, operational risk, liquidity risk, etc. were not taken into consideration.
- Emphasis is put on the book values of assets rather than the market values.
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