The rules: How many losses a bank can absorb

A bank lends other people's money. So one question keeps coming back: how many losses can it absorb before it falls?

The answer fits in one word: capital. It is the shareholders' money, the money that absorbs losses first.

Say a bank with one hundred euros of loans, including eight euros of capital. The rest is deposits and debts.

If eight euros of loans are not repaid, the shareholders lose everything. But the depositors are untouched.

With only three euros of capital, three euros of losses are enough. And beyond that, the depositors pay.

All bank regulation revolves around this cushion. And it is written in a small Swiss city: Basel.

Nineteen eighty-eight, Basel one. For the first time, the major countries set a common rule: eight per cent.

Eight euros of capital per one hundred euros of risk. But not all loans count the same.

A loan to a company counts in full. A home loan, by half. A rich country's government bond: zero.

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Banks learn fast. They fill their balance sheets with what counts little, to lend more with the same cushion.

Two thousand four, Basel two. The largest banks can now measure their risk with their own models.

Four years later, the crisis of two thousand eight showed these models had greatly underestimated the danger.

Two thousand ten, Basel three. More capital, of better quality, and compulsory liquidity reserves.

The core of the cushion rises to at least seven per cent, counting a safety buffer. The largest banks must add more.

Three accords, and each time a crisis to show the holes in the last one. The rule always runs behind the market.

Second tool: stress tests. The regulator invents a disaster, and checks whether the bank survives.

Soaring unemployment, falling property, a stock market slump: everything is applied to the balance sheet, on paper.

In the United States, the exercise is yearly for large banks. In Europe, it takes place every two years.

A known limit: you only test the crises you can imagine. The next one rarely looks like the one you planned for.

That leaves the oldest problem: the bank too big to fail.

If its fall could drag down the whole system, the state will rescue it. And if it knows that, it can take more risks.

The rules have a plan: make shareholders and creditors lose, not taxpayers.

March two thousand twenty-three: Credit Suisse wobbles. The planned process is not used. The authorities arrange its takeover by UBS, in a weekend.

The problem changed in size, not in nature. A bank too big became even bigger.

Remember the essentials: a bank's strength is the size of its cushion. And the rules only make it compulsory.