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.

Charles Calomiris, 28 November 2013

There is widespread agreement that government protection of banks contributed to the financial crisis, leading to proposals to require banks to finance a larger share of their portfolios with equity instead of debt – thus forcing shareholders to absorb losses instead of taxpayers. This column argues that equity ratios relative to asset risk are what matter, not equity ratios per se. Although higher equity requirements for banks may be desirable, the costs of reduced loan supply should be taken into account.

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