Published in: 1988
Published by: Basel Committee on Banking Supervision
Implemented since: 1992
Succeeded by: Basel II
Succeeded since: 2008 (for most countries)
Target: Financial institutions that provide credit worldwide
Goal: 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.
Implemented by: All countries world-wide with but was not ratified by Afghanistan, Haiti and the United States
Despite regulations provided by the Bank of International Settlements (BIS), many banks got into trouble during the crisis in the early 70s. As a response to this, the BIS started a task force of 10 countries to come up with new regulations to enforce the capital of the bank in times of crisis. This task force was given the name: Basel Committee on Banking Supervision (BCBS).
In 1988 they presented their Basel Capital Accord which was later referred to as Basel I.
The main rule is that for each loaned amount 8% of capital must be held available. This will not do justice to many low risk loans and therefore a set of 5 categories is described with their own risk weight.
By reporting each loaned amount in the right category the total amount of capital can be determined.
0% (e.g. home country debt),
10% (e.g. central bank debt to countries with a high inflation in the recent past)
20% (e.g. securitisations such as mortgage-backed securities (MBS) with the highest AAA rating),
50% (e.g. municipal revenue bonds, residential mortgages),
100% (e.g. for example, most corporate debt)
In order to make sure that the capital held available is solid enough a distinction between Tier 1 and Tier 2 capital is made.
Tier 1 capital is the bank's own capital plus reserved profits after tax as mentioned in the financial statements. This definition is equal for all countries.
Tier 2 capital contains of other elements that can be qualified as capital. This is to be determined by each country. It can contain elements like undisclosed profits, revaluation of reserves.
Tier 2 is less solid than Tier 1 and is harder to qualify. To mitigate this Tier 2 may never exceed Tier 1 capital and the capital ratios must be reported against Tier 1 and the total capital.