Meantime, there is a “more-of-the-same-only-more-so” kind of problem, which relates to the Basel regime itself. Much of what went wrong in the crisis was prompted by Basel I. By its nature, a capital adequacy regime raises banks’ capital costs and reduces their profits. The bankers’ response was to push business off the balance sheet and create a shadow banking system that escaped all capital constraints.
Basel III is much tougher on capital than Basel I or the recently implemented Basel II. It is the central plank of the regulatory response to the crisis. Yet that implies that the bankers’ incentive to game the system is even greater than before. The temptation to engage in regulatory arbitrage and find ways of taking increased risk to generate profits to compensate for the capital hit can only be that much greater.
All of this will be compounded by problematic accountancy, since no agreement has been reached on the issue of fair value and considerable uncertainty prevails over the treatment of shadow banking, which looks all too likely to remain shadowy.
It would be too bad if zealous regulators and supervisors fell over themselves in pursuit of un-shadowy banks while the real action was elsewhere.
© Financial Times
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