The first Basel Accord

8/7/2019 The first Basel Accord

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Drafted in 1988 and 2004, Basel I and II have ushered in a new era of international bankingcooperation. Through quantitative and technical benchmarks, both accords have helpedharmonize banking supervision, regulation, and capital adequacy standards across the elevencountries of the Basel Group and many other emerging market economies. On the other hand,the very strength of both accordstheir quantitative and technical focuslimits theunderstanding of these agreements within policy circles, causing them to be misinterpreted

Moreover, even when the Basel accords have been applied accurately and fully, neitheragreement has secured long-term stability within a countrys banking sector. Therefore, afull understanding of the rules, intentions, and shortcomings of Basel I and II is essential toassessing their impact on the international financial system.

The first Basel Accord, known as Basel I, was issued in 1988 and focuses on the capital

adequacy of financial institutions by creating a bank asset classification system. This

classification system grouped a bank's assets into five risk categories:

0% - cash, central bank and government debt and any OECD government debt

0%,10%,20% or50%-public sector debt

20% - development bank debt, OECD bank debt, OECD securities firm debt, non-OECD bank

debt (under one year maturity) and non-OECD public sector debt, cash in collection

50%- residential mortgages

100% - private sector debt, non-OECD bank debt (maturity over a year), real estate, plant and

equipment, capital instruments issued at other banks

The bank must maintain capital (Tier 1 and Tier 2) equal to at least 8% of its risk-weighted

assets..

It should first be noted that Basel I was created to promote the harmonization of regulatory andcapital adequacy standards only within the member states of the Basel Committee. All thestates of the G-10 are considered developed markets by most (if not all) internationalorganizations, and therefore, thestandards set forth in Basel I are tailored to banks operatingwithin such markets.

ANOMALIES:

The agreement expressly states that it is not intended for emerging market economies, and dueto the unique risks and regulatory concerns in these economies, should not be seen as theoptimal emerging market banking reform.Basel I was written only to provide adequate capital to guard against risk in the creditworthinessof a banks loanbook. It does not mandate capital to guard against risks such as fluctuations in anations currency, changes in interest rates, and general macroeconomic downturns. Basel Iovertly states that it only proposes minimum capital requirements for internationally activebanks, and invites sovereign authorities and central banks alike to be more conservative in theirbanking regulations.Because Basel I only covers credit risk and only targets G-10 countries, Basel I is seen as toonarrow in its scope to ensure adequate financial stability in the international financialsystem.


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The inability of these authorities to translate Basel Is recommendations properly into laymansterms and the strong desire to enact its terms quickly caused regulators to over-generalize andoversell the terms of Basel I to theG-10s public. This, in turn, created the misguided view thatBasel I was the primary and last accord a country needed to implement to achieve bankingsector stability.

Due to the wide breath and absoluteness of Basel Is risk weightings, banks have found ways towiggle around Basel Is standards

Although Basel I was never intended to be implemented in emerging market economies, itsapplication to these economies under the pressure of the international business and policycommunities created foreseen and unforeseen distortions within the banking sectors ofindustrializing economies.In response to the banking crises of the 1990s and the aforementioned criticisms of Basel I, theBaselCommittee decided in 1999 to propose a new, more comprehensive capital adequacy accord.Thisaccord, known formally as A Revised Framework on International Convergence of CapitalMeasurement and Capital Standards and informally as Basel II greatly expands the scope,technicality, and depth of the original Basel Accord.


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Documents

The first Basel Accord