Isaak Babel was born into a family of Manus and Feyga Bobel (Babel changed the spelling of his surname in his twenties) in Moldavanka, then an impoverished, largely industrial suburb of Odessa. Babel's family moved to the port city of Nikolayev soon after Babel's birth before returning to live in a more fashionable part of Odessa in 1905, but Babel used Moldavanka as the setting for The Odessa Tales and the play Sunset.

According to Babel's autobiographical statements, his father Manus was a shopkeeper, but, per Babel's daughter Nathalie, who edited the first complete collection of her father's work, Babel fabricated this and other details of his background in order to "present an appropriate past for a young Soviet writer who was not a member of the Communist Party." In fact, Babel's father was a dealer in agricultural machines and owned a warehouse, not a store. While Babel's "autobiographical" short stories present the writer's family as "destitute and muddle-headed" (as he wrote in the story "In the Basement"), they were in fact relatively well-off.

Babel's youth was a period of intermittent pogroms and mass exodus of Jews from the Russian Empire. Isaak Babel's family survived Odessa's 1905 pogrom with the help of Christian neighbors, but his great maternal grandfather Shoyl was one of about 300 Jews murdered.[dubious – discuss]

In his teens, Babel hoped to get into the preparatory class of the Nicolas I Odessa Commercial School. However, he first had to overcome the Jewish quota (10% within the Pale of Settlement, 5% outside and 3% for both capitals). Despite the fact that Babel received the passing grades, his place was given to another boy, whose parents had bribed the school officials. As a result he was schooled at home by private tutors.

In addition to regular school subjects, Babel also studied the Talmud and music. According to Cynthia Ozick,

"Though he was at home in Yiddish and Hebrew, and was familiar with the traditional texts and their demanding commentaries, he added to these a lifelong fascination with Maupassant and Flaubert. His first stories were composed in fluent literary French. The breadth and scope of his social compass enabled him to see through the eyes of peasants, soldiers, priests, rabbis, children, artists, actors, women of all classes. He befriended whores, cabdrivers, jockeys; he knew what it was like to be penniless, to live on the edge and off the beaten track."

After an unsuccessful attempt to enroll at Odessa University (again due to the quota), Babel entered Kiev Institute of Finance and Business. There he met Yevgenia Gronfein, his first wife, a daughter of a well-to-do industrialist. She eventually eloped with Babel to Odessa. Babel graduated from the Institute still under his original surname of Bobel.

In 1915, Babel graduated and moved to Petrograd (now Saint Petersburg), in defiance of laws restricting Jews to living within the Pale of Settlement. Babel's was fluent in French, besides Russian and Yiddish, and his earliest works were written in French, although none of his stories in French have survived.

In the capital Babel met Maxim Gorky who published some of his stories in his literary magazine Letopis' ("Летопись", "Chronicle"). Gorky advised the aspiring writer to gain more life experience and later Babel wrote in his autobiography: "... I owe everything to that meeting and still pronounce Alexey Maksimovich (Gorky's) name with love and admiration." One of his most famous semiautobiographical short stories, "The Story of My Dovecot" ("История моей голубятни"), is dedicated to Gorky.

The story "The Bathroom Window" was considered obscene by censors and Babel was charged with violating criminal code article 1001.