Alea

I have mentioned the Basel “thing” before Culprit N° 1 : Basel II and more
Now John Plender {FT} gets on the case : Basel Accord sits at the root of the ongoing banking crisis

People respond to incentives

It is important to recognise, when considering any response to this continuing debacle, that the extreme nature of this financial cycle is partly the product of the very regulatory system that govern the operations of large financial institutions. Likewise, executives’ behaviour has been a direct response to flawed incentive structures in individual banks.

Back to the pre-Fed days of “free banking”, thanks to the gnomes of Basel

It was the 1988 Basel Accord that first created the opportunity for regulatory arbitrage whereby banks could shunt loans off the balance sheet. In effect, a new capital discipline designed to improve risk management had the unintended consequence of creating a parallel banking system whose lack of transparency explains the market seize-up since August.

There is worse to come

Basel II relies on the modelling techniques that led to the subprime disaster. The new rulebook also depends heavily on the credit rating agencies in whom investors have lost confidence.

Related post at FT Alphaville : Plender spits tacks - blame regulators

Repetitio Est Mater Studiorum, so here is Charles Goodhart a few weeks ago:

But in the longer term the underlying problem will become capital availability, not funding problems and certainly not cash liquidity. Worsening risk raises capital adequacy requirements, and lower profits and higher write-offs reduce the capital base. The Basel II framework for regulating banks’ risk capital will raise the sensitivity of capital adequacy ratios to risk. When it is introduced in Europe at the start of 2008, many banks will find their prior cushions of capital, above the required limit, eroding fast. That could extend and amplify the crisis.
Several of my colleagues at the financial markets group foresaw the dangerous pro-cyclicality of Basel II. Our foreboding may turn into reality sooner than we expected.

Email This

Posted by jck at 2:41 am EST on November 7th, 2007 |