The Missed Opportunity and Challenge of Capital Regulation
19 Pages Posted: 13 Jan 2016 Last revised: 29 Jan 2016
Date Written: December 1, 2015
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.
Keywords: Banking regulation, capital regulations, banking, equity in banking, capital structure, leverage, agency costs, leverage ratchet effect Basel, risk weights, TLAC
JEL Classification: G21, G28, G32, G38, H81, K23
Suggested Citation: Suggested Citation