BASEL PRIMER - BIS & BASEL I

Aditya Lathe

Bank for International

Settlements
Basel I

Bank for International

Settlements
Established: May 1930 at Basel, Switzerland,
after World War I.
Founding Members: United Kingdom, France,
Italy, Japan, Belgium, the United States and
Germany.
Function:
Handling
the
collection,
administration and distribution of annual
reparations (~ $8bn over 59 years) from
Germany to the Allies.
Choice of Switzerland due to its position as
an independent, neutral country; offering
least exposure to undue influence from any of
the major powers.

Organization Structure
Inter-governmental organization, not accountable
to any national government.
Limited Liability Company, with share capital held
by Central Banks / Monetary Authority of 60
countries.

Functions
Bank for Central Banks and
International Organizations.
Forum for discussion and cooperation
among central banks and the financial
community.
Promoting monetary and financial
stability.
Conducting research on policy issues
confronting central banks and financial
supervisory authorities.

Basel Committee on Banking

Supervision (BCBS)
Originally established by Central Bank
Governors of G-10 nations in 1974.
Currently has members from 27 nations
(including India).
Formulates broad supervisory standards &
guidelines, and recommends them to
individual
authorities.
Accordingly,
it
encourages
international
convergence
towards common supervisory approaches &
standards.
Committee has no formal supranational
supervisory authority & its conclusions do not
carry legal force.

BCBS Publications
1988
Basel I

2004
Basel
II

2010
Basel
III

1988 - International Convergence of Capital

Measurement and Capital Standards.
2004 - Basel II: International Convergence of
Capital Measurement and Capital Standards: A
Revised Framework.
2010 - Basel III:
A Global regulatory
framework for more resilient banks and
banking systems.

Bank for International

Settlements
Basel I

Basel I
Consultative document prepared by
G-10 nations in 1988.
Aimed at i) strengthening the
soundness and stability of
international banks ii) diminishing
competitive inequality among banks
Designed to establish minimum levels
of capital for internationally active
banks.
To be applied to banks on a
consolidated basis

Basel I
Focus on Credit Risk and Country
Transfer Risk
Country Transfer Risk incorporated by
grouping countries in terms of
riskiness

The Framework
Capital
for
safeguarding against
risk
Risk
Weighting the
banks loan book for
quantifying risk
Target Standard Ratio
to stipulate minimum
level
of
Capital
required relative to
Risk

Capital

RWAs

Constituents of Capital
Tier I- Core Capital
Equity Capital
Disclosed Reserves
Tier II
Supplementa
ry Capital
(50%)

Tier I
Core Capital
(50%)

Tier II- Supplementary Capital

Undisclosed Reserves
Revaluation Reserves
a) Formal revaluation
b) Latent Revaluation (55%
discount)

General Provisions
Hybrid Debt Capital Instruments
Subordinated Term Debt (Limited
to 50% of Tier I)

Deductions from Capital

Goodwill deducted from Tier I Capital
Investment in unconsolidated BFSI
subsidiaries deducted from Total
Capital.
Investment in capital of other banks
and financial institutions- At the
discretion of national authorities.

Risk Weighting
Direct Credit Exposures: Weighted Risk
Weight Ratio used to relate capital to
different categories of assets, weighted
according to level of riskiness
Contingent Exposures:
Step I- Application of Credit Conversion
Factor (CCF) to account for credit risk of
off-balance sheet exposure (trade related
transactions/guarantees/derivatives)
Step II- Weighted Risk Weight Ratio to
relate capital to riskiness of exposure

Risk Weights (Direct Credit

Exposure)

0%
Cash & Cash
Equivalents

20%

50%

100%
Claims on Pvt.
Sector

Claims on Banks
inc. in OECD

Claims on nonOECD banks, with

loans above 1 year
Claims on Central
Govt. & Central
Bank of home
country

Direct claims on
OECD Central
Govts. & Banks

Claims on MDBs

Claims on banks
outside OECD,
with loans upto 1
year

Housing Loans
fully secured by
residential
property

Claims on nonOECD central

Govts.
Premises, Plant &
Equipment, other
Fixed Assets
All other Assets

CCF (Contingent Exposure)

0%

Credit Lines
with maturity
upto 1 year,
which can be
unconditionally
cancelled.

20%

Short-term self
liquidating
trade credits
(eg. LCs)

50%

100%

Transaction
related
contingent
items (eg.
Performance
Bank
Guarantees)

Direct Credit
Substitutes
(eg. Financial
Bank
Guarantees)

Credit Lines
with maturity
above 1 year

Sale &
Repurchase
agreements,
where Credit
Risk is with the
Bank.

CCF (Derivatives)
Choice between Current Exposure
Method or Original Exposure Method
CEM = Total Replacement Cost (MTM
value of contracts) + Potential Future
Exposure (related to notional principal
amount and residual maturity)

Residual
Maturity

Interest Rate
Contracts

Exchange Rate
Contracts

< 1 year

Nil

1.0%

> 1 year

0.5%

5.0%

Successes
Implementation of the framework by
all Basel committee members (except
Japan) by 1992.
Implementation by all countries
(including India) by 1999.

Failures
Coverage of only Credit Risk
Regulatory Capital arbitrage by some
banks, resulting in higher risk
Method I - Securitization of corporate
loans and sale of least risky assets.
Resultant portfolio is more risky,
however requires lesser capital
according to Basel I
Method II Rolling forward short run
non-OECD bank debt instead of long

Thank You

References
BIS Website (www.bis.org)
Basel I Accord
Basel I, Basel II, and Emerging
Markets: A Nontechnical Analysis by
Bryan J Balin
Wikipedia