The Evolution to Basel II (part 2)

Credit Risk - Basel I

 
 
 
  • Core (Tier I) and Supplementary (Tier II) Capital
  •  
  • On Balance Sheet and Off Balance Sheet Assets
  • Assigns risk weighting to different asset classes to obtain a Credit Risk Adjusted Asset Value
 
Credit Risk - Capital
 

The Evolution to Basel II

First Basel Accord
The first Basel Accord (Basel I) was completed in 1988
  • Set minimum capital standards for banks
  • Standards focused on credit risk, the main risk incurred by banks
  • Became effective end-year 1992


To create a level playing field for internationally active banks

  • Banks from different countries competing for the same loans would have to set aside roughly the same amount of capital on the loans

1988 Accord Capital Requirements
Capital was set at 8% and was adjusted by a loan’s credit risk weight. Credit risk was divided into 5 categories: 0%, 10%, 20%, 50%, and 100%

  • Commercial loans, for example, were assigned to the 100% risk weight category
Risk-Based Capital
The Accord was hailed for incorporating risk into the calculation of capital requirements
 
Enforcement of Capital Adequacy
Two Capital Requirements
-Leverage Ratio
-Risk-Based Capital Ratio

Leverage Ratio = Core Capital / Assets
Risk-Based Approach implemented by Bank of International Settlements (BIS)
-Basel Agreement
Reason for the Accord