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Basel I - 1988: Tier 1

The document summarizes the Basel Accords from 1988 to 2011 that established international standards for bank capital adequacy. Basel I defined Tier 1 core capital and Tier 2 supplemental capital. It categorized banks as well, adequately, under, significantly under, and critically undercapitalized based on capital ratios. Basel II built on three pillars focusing on risk quantification, supervisory review, and market discipline. Basel III further increased minimum capital requirements, introduced a capital conservation buffer, and set higher common equity standards to strengthen bank capital reserves.

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41 views3 pages

Basel I - 1988: Tier 1

The document summarizes the Basel Accords from 1988 to 2011 that established international standards for bank capital adequacy. Basel I defined Tier 1 core capital and Tier 2 supplemental capital. It categorized banks as well, adequately, under, significantly under, and critically undercapitalized based on capital ratios. Basel II built on three pillars focusing on risk quantification, supervisory review, and market discipline. Basel III further increased minimum capital requirements, introduced a capital conservation buffer, and set higher common equity standards to strengthen bank capital reserves.

Uploaded by

Madel BA
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Basel I - 1988

The Basel I definition of capital is made up of two elements: Tier 1 (‘core


capitalʼ) and Tier 2 (‘supplemental capitalʼ). Bank total capital is the sum
between Tiers 1 and 2 (‘capital baseʼ).

Specifically, the elements of capital are:

Tier 1

(a) Ordinary paid-up share capital/common stock (b) Disclosed reserves

Tier 2

(a) Undisclosed reserves


(b) Asset revaluation reserves
(c) General provisions/general loan loss reserves (d) Hybrid (debt/equity)
capital instruments
(e) Subordinated term debt

The general framework for capital adequacy risk-weighted assets can be


summarised as follows. There are four risk classes in the weighted-risk system
that reflects credit risk exposure:
!. No risk: 0%
#. Low risk: 20%
$. Moderate risk: 50%
%. Standard risk: 100%

There are 5 capital-adequacy categories of banks:


!. Well capitalised:
- total capital to risk-weighted assets 10%
- tier 1 capital to risk-weighted assets 6%
- tier 1 capital to total assets 5%
#. Adequately capitalised:
- total capital to risk-weighted assets 8%
- tier 1 capital to risk-weighted assets 4%
- tier 1 capital to total assets 4%
$. Undercapitalised:
Fails to meet one or more of the capital minimums for an adequately
capitalised bank
%. Significantly undercapitalised:
- total capital to risk-weighted assets <6%
- tier 1 capital to risk-weighted assets <3%
- tier 1 capital to total assets <3%
`. Critically undercapitalised:
(Common equity capital + perpetual preferred stock - intangible assets)/
total assets <2%

Basel II - 2006

Basel II is built on three main pillars. Pillar 1 deals with the quantification of new
capital charges and relies heavily on banksʼ internal risk-weighting models and
on external rating agencies. Pillar 2 defines the supervisory review process and
Pillar 3 focuses on market discipline, imposing greater disclosure standards on
banks in order to increase transparency.

Basel III - 2011

The main elements of the Basel III capital framework are:


● (i)  higher minimum Tier 1 capital requirement;

● (ii)  a capital conservation buffer;

● (iii)  a countercyclical capital buffer;

● (iv)  higher minimum Tier 1 common equity requirement;

● (v)  minimum total capital ratio.

Tier 1 capital from 4% to 6%. Tier 1 capital is comprised of common equity and
retained earnings.

New capital conservation buffer is 2.5%. Total common equity requirement is


7%. This is the sum of 4.5 per cent common equity requirement and the 2.5 per
cent capital conservation buffer.

Basel III also introduces a countercyclical buffer within a range of 0–2.5 per
cent of common equity (or other fully loss-absorbing capital). This is in effect
an extension of the conservation buffer and will be implemented according to
national circumstances.

Tier 1 common equity requirement went from 2% to 4.5%.

The minimum total capital ratio will remain at 8 per cent. The addition of the
capital conservation buffer increases the total amount of capital a bank must
hold to 10.5 per cent of risk-weighted assets, of which 8.5 per cent must be
Tier 1 capital.

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