Basel Requirements

🏦 Basel Requirements: The Bank Safety Rulebook

The Big Picture: Why Banks Need Rules

Imagine you have a piggy bank. You put coins in, and sometimes you take them out to buy candy. But what if you took out ALL your coins and then someone else needed coins? You’d have nothing to give!

Banks work the same way. They hold money for millions of people. If they run out of money when people need it, that’s called a bank failure—and it’s VERY bad for everyone.

Basel Requirements are like the rules your parents give you for your piggy bank:

• “Always keep some coins saved”
• “Don’t spend more than you have”
• “Tell us how much you have”

These rules keep banks safe so YOUR money stays safe!

🧱 The Three Pillars: The Bank Safety Triangle

Think of a three-legged stool. Each leg is super important—remove one, and the stool falls over!

graph TD
    A["🏛️ Basel Framework"] --> B["Pillar 1<br/>Minimum Capital"]
    A --> C["Pillar 2<br/>Supervisory Review"]
    A --> D["Pillar 3<br/>Market Discipline"]
    B --> E["💰 How much money<br/>banks MUST keep"]
    C --> F["👀 Regulators<br/>watching banks"]
    D --> G["📢 Banks tell<br/>everyone their info"]

💰 Pillar 1: Minimum Capital

What Is It?

Capital = The bank’s own money (not money people deposited)

Think of it like this:

• You have $100 in your piggy bank
• $80 belongs to your friends (they asked you to hold it)
• $20 is YOUR money

That $20 is your capital. If something goes wrong, you use YOUR money first, not your friends’ money!

The Magic Number: 8%

Banks must keep at least 8% of their risky stuff covered by their own money.

Simple Example:

If a bank has $1,000 in risky assets, it needs at least $80 of its own money as a safety cushion.

🛡️ Capital Conservation Buffer

The “Rainy Day Fund” Rule

Remember when mom said, “Save some candy for later”? That’s what this is!

The Capital Conservation Buffer says: “Keep an EXTRA 2.5% cushion on top of the minimum.”

Why? So when bad times come (like a recession), banks have extra money to keep working.

graph TD
    A["Minimum Capital: 8%"] --> B["+ Conservation Buffer: 2.5%"]
    B --> C["Total: 10.5%"]
    C --> D["🎯 This keeps banks<br/>safe in storms!"]

Real Life Example:

• Bank has $1,000 in risky assets
• Needs $80 minimum (8%)
• PLUS $25 extra buffer (2.5%)
• Total needed: $105

If a bank dips into this buffer, it faces restrictions—like not being allowed to pay big bonuses to bosses!

🔄 Countercyclical Buffer

The “Boom and Bust” Shield

Imagine a seesaw. When the economy goes UP (boom), banks should save MORE. When it goes DOWN (bust), they can use those savings.

Countercyclical = Counter (opposite) + Cyclical (the ups and downs)

Example:

During good times in 2019, regulators said: “Banks, keep 1% extra!”

Then COVID hit in 2020. Regulators said: “Okay, you can use that 1% now to help people.”

It’s like wearing a heavier coat when it’s sunny so you’re warm when winter comes!

⚖️ Leverage Ratio

The “Don’t Borrow Too Much” Rule

Leverage = Using borrowed money to do more stuff

Imagine you have $10. Your friend lends you $90. Now you have $100 to invest! But if your investment loses just $10, you’ve lost ALL your own money!

The Leverage Ratio says: “Your own money must be at least 3% of EVERYTHING you have.”

graph TD
    A["Total Assets: $100"] --> B[Bank's Own Money<br/>Must be at least $3]
    B --> C["Leverage Ratio = 3%"]
    C --> D["🎯 Stops banks from&lt;br/&gt;being too risky!"]

Simple Math:

🏢 Systemically Important Banks (SIBs)

The “Too Big to Fail” Problem

Some banks are SO big that if they fall, they bring everyone down with them—like the biggest domino in a chain.

Systemically Important Banks are these giant banks. They have EXTRA rules!

Two Types:

1. G-SIBs = Global Systemically Important Banks (worldwide giants)

   • Examples: JP Morgan, HSBC, Bank of China

2. D-SIBs = Domestic Systemically Important Banks (big in one country)

   • Important in their home country

Extra Requirements:

Why? Because when a giant falls, EVERYONE feels it. Extra cushion = extra safety for everyone!

👀 Pillar 2: Supervisory Review

The “Teacher Checks Your Work” Rule

Remember when teachers walked around the classroom checking if you’re doing your homework right?

Supervisory Review = Regulators checking each bank individually

Four Key Principles:

graph TD
    A["Pillar 2: Supervisory Review"] --> B["1️⃣ Banks assess<br/>their own risks"]
    A --> C["2️⃣ Supervisors review<br/>bank assessments"]
    A --> D["3️⃣ Banks should hold<br/>MORE than minimum"]
    A --> E["4️⃣ Supervisors can<br/>intervene early"]

What Supervisors Look At:

• Is the bank managing risks well?
• Does it have good systems?
• Is leadership making smart decisions?
• Are there hidden problems?

Example: A bank might meet the 8% minimum, but a supervisor notices it has risky loans. The supervisor says: “You need 12% for safety!”

🔍 Internal Capital Assessment (ICAAP)

The “Know Yourself” Homework

Every bank must do homework called ICAAP (Internal Capital Adequacy Assessment Process).

It’s like writing a report that answers:

• What could go wrong?
• How much money would we need if bad things happen?
• Do we have enough cushion?

ICAAP Steps:

Example: A bank that gives lots of home loans thinks: “What if house prices drop 30%? We’d need an extra $50 million in capital.”

📢 Pillar 3: Market Discipline

The “Show and Tell” Rule

Remember show-and-tell at school? Banks have to do this too!

Market Discipline = Banks must tell EVERYONE important information about their health.

Why This Works:

graph TD
    A["Bank Publishes<br/>Information"] --> B["Investors Read It"]
    A --> C["Other Banks<br/>Read It"]
    A --> D["Regular People<br/>Can See It"]
    B --> E[Bad info = People<br/>don't invest]
    C --> E
    D --> E
    E --> F["🎯 Banks try to&lt;br/&gt;look good by BEING good"]

What Banks Must Share:

• How much capital they have
• What risks they’re taking
• How they calculate risk
• Who runs the bank

Example: If Bank A shows it has low capital and high risk, investors might say “No thanks!” and put their money in safer Bank B. This pressure makes Bank A improve!

🎯 Putting It All Together

The Complete Picture

Here’s how ALL these requirements work together:

graph LR
    A["🏦 Healthy Bank"] --> B["Pillar 1:<br/>Minimum Capital 8%"]
    A --> C["+ Conservation<br/>Buffer 2.5%"]
    A --> D["+ Countercyclical<br/>Buffer 0-2.5%"]
    A --> E["+ SIB Buffer<br/>if applicable"]
    A --> F["Pillar 2:<br/>Supervisor says OK"]
    A --> G["Pillar 3:<br/>Public can see info"]
    B --> H["💪 Total Safety<br/>Cushion: 10.5%+"]
    C --> H
    D --> H
    E --> H

Quick Summary Table:

🌟 Why This All Matters to YOU

Every time you:

• Put money in a savings account
• Your parents get a home loan
• A business gets money to hire people

…banks are involved. Basel Requirements make sure banks stay healthy so:

✅ Your savings are safe ✅ Banks can lend money when people need it ✅ The economy keeps running smoothly ✅ We avoid disasters like the 2008 financial crisis

Banks with good cushions = A safer world for everyone!

🎉 You Made It!

You now understand the key rules that keep the world’s banks safe:

1. Pillar 1 - Keep enough of your own money (capital)
2. Conservation Buffer - Extra savings for hard times
3. Countercyclical Buffer - Save more when times are good
4. Leverage Ratio - Don’t borrow too much
5. SIBs - Giant banks need giant cushions
6. Pillar 2 - Let supervisors check your work
7. Pillar 3 - Tell everyone how healthy you are
8. ICAAP - Know your own risks

Congratulations! You now know more about banking safety than most adults! 🏆