Xavier Vives, 22 December 2014

Banking has recently proven much more fragile than expected. This column argues that the Basel III regulatory response overlooks the interactions between different kinds of prudential policies, and the link between prudential policy and competition policy. Capital and liquidity requirements are partially substitutable, so an increase in one requirement should generally be accompanied by a decrease in the other. Increased competitive pressure calls for tighter solvency requirements, whereas increased disclosure requirements or the introduction of public signals may require tighter liquidity requirements.

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