Let's start having a look at the Basel regulations, and Basel One specifically. First of all, what are the Basel Accords? Well, first of all they're bank regulations, they apply to banks. Those regulations are set by the Basel committee on bank supervision, the BCBS, which is headquartered at the bank of international settlements in Basel Switzerland, but the BCBS is a different entity from the BIS. The Basel Committee makes recommendations, and those recommendations are then enforced through local laws in states and nations that comply with the Basel Accords. After that, the banks are regulated by the local bank regulators. Compliance globally might vary a little bit, but we can think of the Basel Accords as global accords. Right, so why did they come about? Well, before Basel One, an increasingly global financial system needed a consistent approach to regulations so that the banks could compete on a level playing field. And if you were doing business with a foreign bank you wanted to know roughly what to expect. You wanted to know that it was regulated in a similar way to yourself. Prior to Basel One, regulation had been way too simplistic, and it penalized the more sophisticated institutions internationally. Right, so we wanted to have a system here that ensured that share holders equity, the main buffer against future loses, was sufficient in relationship to some measure of assets. Now what the Basel Accords did was saying not all assets are the same, so Basel One weighted those assets according to the the risk. The riskier the asset, the higher the risk weighted.

Let's have a look at an example of Basel One calculation of risk-weighted assets. Very simplistic here. And please note that we have simplified these calculations quite a lot. Look at the asset side. This bank has cash, 40 million worth of. Cash is very stable, it's very liquid, and it's pretty much risk free. It is therefore assigned a risk weighting of zero. But as the assets get more risky, we assign higher risk weightings. So the mortgages, they get a risk weighting of 50% and the property plant and equipment, which is not a loan of course, but just assets, receives a risk weighting of 100%. Government bonds, of course, totally safe, risk weighting of zero. Now once we've established a total risk weighted assets of the business, in this case 200, it's time to compare those assets to our buffers against losses, which is essentially equity. Basel One was looking at tier one capital as the most important buffer against future losses, and it's essentially the total equity of the business minus the good will of the business. The reason we take away the good will here is that good will is deemed to be valueless in a bankruptcy scenario. Basel One was also looking at tier two capital as another measure of the strength of the business. Once you've done all this, you've got your tier one capital, you've got your risk-weighted assets, you've got your tier two capital in relation to risk-weighted assets, you now have these two ratios that were the key of establishing the safety of different institutions and banks internationally.