Are Banks Safe? Do we Really Know? Thoughts on Risk Weighting and Regulatory Arbitrage

During the global financial crisis, people in the United States, Ireland, Iceland, and many other countries learned that undercapitalized banks can spell trouble for the whole economy. The Basel II rules that were supposed to prevent widespread bank failures proved inadequate. In response to the crisis, the world’s central bankers and bank regulators started work on a new set of rules, Basel III, that they have promised will make us safer.

Now Basel III has reached the crucial phase of writing the technical rules to implement the agreed principles. Many observers are worried that each round of rule-making will provide an opportunity for watering down the regulations until what is left is no more effective than Basel II was. This post looks at one key aspect of the new rules, the regulation of bank capital, as an illustration of the broader difficulties facing the effort to regulate banking risk more effectively. >>>Read more

If you liked this post, be sure to check out these related slideshows, both newly updated:
What is Basel III and Why Should we Regulate Bank Capital?
More on Financial Regulation and Basel III: Regulating Bank Liquidity