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The missed opportunity and challenge of capital regulation

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The author says that Basel 3 capital requirements are inadequate for several reasons. i. Required equity levels are much too low, ii. use of complex manipulable risk weights that ignore some risks exacerbates systemic risk and distorts incentives, and iii. debt-like securities are used in the regulations although they are complex, unreliable, and entirely dominated by equity.

Standford University working paper No 3386
published in: National Institute Economic Review No 235, Febr. 2016

15 December 2015
Source: Stanford University

Author:
Anat Admati, Stanford University

>  The missed opportunity and challenge of capital regulation

Abstract:

Capital regulation is critical to address distortions and externalities from intense conflicts of interest in banking and from the failure of markets to counter incentives for recklessness. The approaches to capital regulation in Basel III and related proposals are based on flawed analyses of the relevant tradeoffs. The flaws in the regulations include dangerously low equity levels, complex and problematic system of risk weights that exacerbates systemic risk and adds distortions, and unnecessary reliance on poor equity substitutes. The underlying problem is a breakdown of governance and lack of accountability to the public throughout the system, including policymakers and economists.

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