11 September 2010

Basel Three: Some Links

Basel III, as many of my readers presumably know, is the latest round of the internationalization of banking regulation. The Basel Committee on Banking Supervision consists of regulatory and central bank representatives from nearly 30 countries, who sometimes hobnob in the Swiss city of that name and work on common rules and principles. Here's a link to a pre-crisis book on the Accords from Wiley Finance.

The banking crisis of 2008 gave several of the central bankers involved the idea that there was more work for them to do.

The core of it is deciding how much "Tier 1 Capital" (which, roughly speaking, means what accountants mean by the word "equity") that a bank should have, in order to ensure that it will not require a public bail-out.

Instead of saying anything substantive about Basel III now, I'll just offer some links. Sometimes I'm lazy that way.

Felix Salmon has had a lot to say on the subject, as for example or again here.

My understanding is that the gist of a Basel III Accord has been developed, and this weekend the world's banking mandarins are sweating the fine print so they can announce a done deal.

Under Basel II, the existing system, a bank must have "capital" equal to 8% of the weighted at-risk value of its assets. Never mind for now how the risk weighting is done. The point here is that under Basel II, the capital necessary to reach that 8% figure can be both Tier I and Tier II capital, though at least 50% of that must be Tier I.

Tier II Includes things like hybrid debt-equity instruments and subordinated long-term debt. In other words, it is not obvious that Tier II capital is available to address the sorts of emergency that banks faced in 2008. Since the idea is to ensure that banks can face and overcome such emergencies without taxpayer bail-outs, the natural impulse is to re-write the rules to put more emphasis on Tier I.

Not all Tier I capital is alike, though. There is a "core" of Tier I, and more peripheral components thereof. The new accord seems likely to say that banks will have to maintain a capital ratio of 8% in Tier I, effectively rendering Tier II irelevant. Futhermore, most of that capital a (7% ratio to at-risk assets) will
have to be from the core.

What is more confusing still is that the Basel system works not only through distinct Tiers, but through distinct "Pillars". The whole issue of regulatory capital as discussed above is only "Pillar 1". Pillar 2 deals with how risks are weighted and Pillar 3 with disclosure matters. Here's one final link just for fun.

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