The Basel Accords Made Simple

“Basil?” “Yes, Sybil” always reminds me of these rules but they’re nothing to do with hoteliers in Torquay, more to do with overcooked bank lending.

Basel, in Switzerland, is where the famous accords were agreed, a committee set up to decide how much capital banks needed to lend safely. The UK got on board with the accords along with other rich nations. It’s not related to the EU although the EU has brought about their Capital Requirement Directives to make sure the Basel accords are put into UK law.

There have been 3 Basels so far, the latest, Basel 3, has only just been implemented.

Basel 2 required that banks hold adequate capital to support it’s lending appropriate to the risk it encountered. The accord specified:

  • Capital requirements
  • Supervisor “teeth” for regulators
  • Disclosure rules
  • Stress testing

The stress testing is different from the interest rate stress testing imposed on borrowers, but the concept is similar. These are simulated computer models that run scenarios to see how well large banks survive systemic risks, like future financial crashes.

Talking of bank crashes, a direct result of the Banking Crisis of 2008, brought about the sequel – Basel 3. Two areas we need to know about.

Regulatory capital – the higher the risk with the lending, the greater the capital required. Plenty of percentages here ensuring banks remain capital-rich to support their lending and growth and remain solvent. Solvency ratios of 7% - this ratio looks at whether a bank’s cash flow is sufficient to meet its future payments. Two tiers of capital were created, these are essentially the money the bank “owns” and keeps in the vaults. Capital divided by its assets can’t exceed 3%.

Worth remembering those numbers if you have an exam coming up.

Asset and Liability Management is the second aspect of Basel 3 certifying that banks have assets to support their business. The first one, liquidity coverage ratio, means that liquid assets are available to cover any outgoings over 30 days. A little bit like you keeping enough cash in your current account to pay all your bills unto next payday. A further ratio is needed to protect beyond 30 days, known as the net stable funding ratio; quite like you holding plenty of future salary payments to cover your yearly outgoings.

Only 12 episodes were ever made in only one season of Fawlty Towers, but I imagine we’ll very soon get to Basel 13.

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