Gene Ambrocio, Esa Jokivuolle, 14 May 2018

The Basel III reform raised banks’ capital requirement per risk-weighted assets considerably, while risk weights were largely unchanged. This column uses a simple model to explore whether these risk weights discourage productive business investments. The model shows that when firms face collateral constraints, the optimal risk weights on corporate loans should be ‘flatter’ than they are at present. A quantitative assessment, however, suggests that welfare losses from the current system may not be large.

Banu Demir, Tomasz Michalski, Evren Örs, 20 January 2017

The negative impact of higher capital requirements under Basel II on the provision of trade finance has been cited as one of the factors behind the Great Trade Collapse. This column exploits the adoption of the Basel II framework in Turkey in 2012 to investigate how a shock to the supply of trade-specific finance (in this case, letters of credit) affected firm-level exports. Changes in the cost of letters of credit affected Turkish firms’ reliance on trade finance, but the regulatory shock did not affect firm-level export growth.

Patricia Jackson, 18 May 2016

An ongoing issue for banking regulation is the extent to which regulators should move away from risk-sensitive capital requirements towards simpler requirements, such as the leverage ratio. This column looks at the evidence that has influenced the debate and shows that none of the analyses to date has tested the risk-based credit requirements of Basel II against leverage. It also sets out two new tests that do test Basel II and produce a different result from the earlier analyses, highlighting the importance of risk sensitivity.

Philippe Bacchetta, Ouarda Merrouche, 16 January 2016

Economists now tend to stress the role of global banks in the transmission of the Global Crisis. This column argues that the retrenchment of Eurozone banks opened regulatory arbitrage opportunities for US banks. The fact that US banks, and in particular the most risky US banks, fully exploited these opportunities had a salubrious effect on credit-constrained corporates and employment. It seems the move from Basel I to Basel II with risk-sensitive capital requirements amplifies the credit cycle.

Xavier Vives, 17 March 2015

The 2007–08 crisis revealed regulatory failures that had allowed the shadow banking system and systemic risk to grow unchecked. This column evaluates recent proposals to reform the banking industry. Although appropriate pricing of risk should make activity restrictions redundant, there may nevertheless be complementarities between these two approaches. Ring-fencing may make banking groups more easily resolvable and therefore lower the cost of imposing market discipline.

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.

Mike Mariathasan, Ouarda Merrouche, 26 May 2013

This paper examines the relationship between banks’ approval for the internal ratings-based (IRB) approaches of Basel II and the ratio of risk-weighted over total assets. Analysing a panel of 115 banks from 21 OECD countries that were eventually approved for applying the IRB to their credit portfolio, we find that risk-weight density is lower once regulatory approval is granted. The effect persists when we control for different loan categories, and we provide evidence showing that it cannot be explained by flawed modelling, or improved risk-measurement alone. Consistent with theories of risk-weight manipulation, the authors find the decline in risk-weights to be particularly prevalent among weakly capitalised banks, when the legal framework for supervision is weak, and in countries where supervisors are overseeing many IRB banks. They conclude that part of the decline in reported riskiness under the IRB results from banks’ strategic risk-modelling.

Marc Auboin, 07 March 2010

Trade finance is an essential facility for world trade. But this column argues that the safe, short-term, and self-liquidating character of trade finance has not been properly recognised under the Basel II framework and the proposed revised rules ("Basel III") seem to raise additional hurdles to trade finance. Both trade financiers and regulators should strive to avoid this.

Rafael Repullo, Jesús Saurina, Carlos Trucharte, 24 September 2009

One widespread concern about Basel II’s risk-sensitive bank capital requirements is that they may amplify business cycle fluctuations. This column argues that the best way to correct this procyclicality is to use a business cycle multiplier of the Basel II capital requirements that is increasing in the rate of growth of the GDP. Under such a scheme, riskier banks would face higher capital requirements without regulation exacerbating credit bubbles and crunches.

Hyun Song Shin, 31 January 2009

Today’s financial regulation is founded on the assumption that making each bank safe makes the system safe. This fallacy of composition goes a long way towards explaining how global finance became so fragile without sounding regulatory alarm bells. This column argues that mitigating the costs of financial crises necessitates taking a macroprudential perspective to complement the existing microprudential rules.

Rafael Repullo, Javier Suarez, 14 July 2008

Basel II’s goal was to reduce incentives for excessive risk taking. Making banks’ capital requirements risk-sensitive, however, also set the system up for credit crunches during economic down turns. This column argues that small cyclical adjustments to the confidence levels set by regulator could preserve Basel II’s value-at-risk foundation while avoiding painful credit crunches during periods of economic distress.

Alberto Giovannini, Luigi Spaventa, 05 November 2007

The Basel Committee on Banking Supervision and the Basel II framework were intended to mitigate or prevent crises like the subprime mess. The valuation practices and market transparency recommended by the Committee fall short of what is needed.


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