Bank capital requirements: Risk weights you cannot trust and the implications for Basel III
Jens Hagendorff, Francesco Vallascas 16 December 2013
Recent research shows that capital requirements are only loosely related to a market measure of bank portfolio risk. Changes introduced under Basel II meant that banks with the riskiest portfolios were particularly likely to hold insufficient capital. Banks that relied on government support during the crisis appeared to be well-capitalised beforehand, suggesting they engaged in capital arbitrage. Until the regulatory concept of risk better reflects actual risk, the proposed increases in risk-weighted capital requirements under Basel III will have little effect.
One of the primary purposes of bank capital is to absorb losses. Where bank capital holdings are insufficient to absorb losses, banks will either fail or – if bank failure is deemed too costly for the economy – be bailed out. In practice, banks frequently receive public funds where capital holdings are insufficient to cover losses in order to prevent bank failure. Whether or not bank capital holdings are sufficient and in line with the risk of bank portfolios is therefore an important question that is hotly debated among policymakers and in the press.
Financial markets Microeconomic regulation
Basel II, financial crisis, capital requirements, BASEL III, Basel, bank capital, risk weighting, capital adequacy
New challenges for bank competition policy
Lev Ratnovski 02 June 2013
Bank competition policy seeks to balance efficiency with incentives to take risk. This calls for an intermediate degree of competition. This column argues that although the traditional policy tools are rules on entry/exit and the consolidation of banks, the Crisis showed that a focus on market structure alone is misplaced. There are other, newer ways in which competition policy can support financial stability: dealing with too-big-to fail and other structural issues in banking, as well as facilitating crisis management.
Bank competition policy has been a focus of much research and policy debate. The reason for this is the special nature of banks. In the non-financial sector, competition policy mainly focuses on efficiency (competitive pricing). Yet for banks there is another relevant dimension: systemic risk. When the degree of competition adversely affects banks’ risk-taking incentives, bank competition policy should have a macroprudential component.
Competition policy Global crisis International finance
banking, banks, Competition policy, Basel
Implementation of Basel III in the US will bring back the regulatory arbitrage problems under Basel I
Takeo Hoshi 23 December 2012
Rejigging financial regulation is in vogue. But, in the world of international finance, how well do different regulatory systems join up? This column argues that the US Dodd Frank Act and Basel III are, in part, incompatible and that harmonising them may lead to unintended consequences. The US ought to tread carefully here but should also try hard to maintain the spirit of better financial regulation.
This column is a lead commentary in the VoxEU Debate "Banking reform: Do we know what has to be done?"
regulation, banks, Basel, Dodd-Frank, Finance
Systemic liquidity risk: A European approach
Enrico Perotti 25 October 2011
How should financial regulators address problems stemming from liquidity risk? This column argues that the liquidity coverage and net funding ratios proposed for Basel III are economically and politically impractical. It recommends using those ratios as long-term targets while imposing ‘prudential risk surcharges’ on deviations from the targets.
The repeated bursts of financial distress in Europe in 2010-11 reflect vulnerabilities built up in the previous decade and are germane to the roots of the credit crisis.
Financial markets International finance
liquidity risk, Basel, hot money
The Empire strikes back
Avinash Persaud 14 September 2010
The role of financial institutions in the global crisis has led to a consensus that financial regulation must change. This column argues that the banking lobby, far from depleted, has struck back with a vengeance. It has managed to postpone the much needed regulation for a time when the need for it will be forgotten.
There are two remarkable aspects of the consensus around international financial regulation emerging in the run up to the November G20 meeting in Seoul. The first is that there is a consensus. International regulators are agreed that banks must set aside much more capital for risky assets; be less dependent on the whims of money markets; constrain the maturity mismatches between their assets and liabilities and set aside capital for holding complex derivatives where there may be settlement and clearing risks.
Global crisis International finance
financial regulation, global crisis, banking, Basel