Glossary

Basel Accords

The Basel Accords are international banking regulations issued by the Basel Committee on Banking Supervision. Its secretariat is based at the Bank of International Settlements in Basel, Switzerland.

Although Basel Committee recommendations have little formal authority, they have been widely adopted by national governments. Basel I established minimal standards for assessing ‘credit risks’ taken on by banks, setting a minimum capital requirement equivalent to 8 per cent of their overall lending, at least half of which needed to be ‘Tier 1’ capital (the safest form, including shares and retained profits). Basel II, initially published in 2004, extended the scope of the agreement to take account of ‘market risks’ (price fluctuations) and ‘operational risk’ (potential failures in bank’s internal processes). Although the USA and other major economies signed up to Basel II, its implementation was delayed and limited. Banks, meanwhile, responded to the Basel Accords by increasing the securitization of their assets. This took lending off their books and loaded it into special purpose vehicles – newly formed companies, mostly registered in tax havens, beyond the view of regulators. They also offloaded some risk to hedge funds.

Basel III, agreed in light of the financial crisis, raises the bar for ‘Tier 1’ capital from 4 to 6 per cent, redefines ‘Tier 1’ to include only ‘common’ or ‘preference’ shares (those with voting rights, whose investors are among the first to be repaid from remaining assets in case a company goes bankrupt) and cash held over and not reinvested from the bank’s profits. Other key changes include extending the definition of risk to include certain types of derivatives, and introducing new leverage and liquidity ratios for banks to comply with.

As Basel III is rolled out, more lending could shift away from bank loans and on to capital markets. In particular, this may result in more climate bonds or forest bonds, as well as a greater use of private equity in project finance .

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