The Principles of Banking, 2nd Edition

CHAPTER 3Bank Regulatory Capital and the “Basel Rules”¹

Abstract

In the era before bank regulation, all banks would have held a portion of their balance sheet liabilities in the form of their own funds, the shareholders' equity. The capital amount required to be held by banks today is given by a country's own legal rulings, and in virtually every country in the world follows guidance published by a special committee of the Bank for International Settlements. These guidelines are known as the Basel rules, and since the last century banks have seen three versions of them, known as Basel I, Basel II and Basel III. Each successive iteration of Basel guidance has increased the level of complexity and intrusiveness in national rulings.

In Chapter 1 we noted the importance of capital to the basic business of banking. The ratio of a bank's total capital to its overall balance sheet is one of the hallmarks of a firm's overall financial health, and as the capital buffer is required to cover all (expected and unexpected) losses suffered by the bank, it is the target of bank regulators' rulings. Before we had official supervision and bank regulation – which was indeed the norm before the 20th century – banks would have held a share of their balance sheet liabilities in the form of their own equity, that is, shareholders' funds. Since the latter part of the 20th century the amount of this equity, or capital, to be held is governed by national law.

In this chapter we discuss bank regulatory ...