The 1988 Basel Accord (Basel I)

The 1988 Basel Accord, also known as Basel I, established minimum capital standards for the banking industry by linking the banks’ capital requirements to their capital exposures. Basel I primarily focused on credit risk.

The credit exposures were divided into five categories that represented similar types of borrowers. Each category is tied to a specific risk weight, which is used to calculate the total capital requirements

Five risk categories encompass all assets on a bank’s balance sheet. These categories and their risk weights are described below:

Risk weightAsset Category
0%Cash and gold bullion, claims on OECD governments such as Treasury bonds, or insured residential mortgages
20%Claims on OECD banks and OECD public sector entities such as securities issued by U.S. government agencies or claims on municipalities.
50%Uninsured residential mortgages
100%All other claims, such as corporate bonds and less-developed country debt, claims on non-OECD banks, equity, real estate, premises, plant and equipment.
VariableClaims on domestic public sector entities, which can be valued at 0, 10, 20, or 50% depending on the central bank’s discretion.

As an example, an uninsured residential mortgage of $10,000 will carry a risk weight of 50%. So, the risk weighted assets will be $10,000*50%, i.e., $5,000.

As per Basel I, banks with international presence are required to hold capital equal to 8% of the risk-weighted assets. This is also known as the Target Standard Ratio. It sets a universal standard whereby 8% of a bank’s risk-weighted assets must be covered by Tier 1 and Tier 2 capital reserves. Moreover, Tier 1 capital must cover 4% of a bank’s risk-weighted assets. This ratio is seen as “minimally adequate” to protect against credit risk in deposit insurance-backed international banks in all Basel Committee member states.

The capital requirements could be calculated using the following formula:

Capital ratio (min 8%) = Total Capital/Risk-weighted assets

In our example above, the minimum required capital will be 8% of $5,000, i.e. $400.

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