As Joe Nocera explains, the whole Value-at-Risk structure gives banks every incentive to push risk into the tails. Still, the tail risk remains. The main one is the whole concept of risk weighting: If that happens, anyone want to guess where the next crisis will crop up? The problem is that as a result, banks are incentivized to load up on the kind of securities which can blow up in unforeseeable ways.
The big-picture point to take home is: Banks will need to hold more common equity than ever—against their risk-weighted assets.
But why did they hold so much of this debt? The problem is that while Basel II was a bold experiment which took a decade to put together and which even then never really got implemented, Basel III was much more of a rush job, and therefore could not be a soup-to-nuts reimagining of what a global macroprudential regulatory regime should look like.
So one result of Basel III could be to encourage banks to increase their lending to sovereigns at the margins of zero-risk-weight status. Ultimately, Basel III does a good job of reducing foreseeable risks, and, like any ex ante regulatory structure, it does a bad job of reducing unforeseeable risks.
And because tail risk can be ignored, banks then go on to embrace other mechanisms — like the Gaussian Copula Function — which essentially fatten the tails, stuffing them with ever more risk.
The book was actually pretty kosher. The consequence of this Basel II reform was to discourage banks from lending to risky enterprises, and to encourage the accumulation of apparently risk-free assets.
Which also happens to be the biggest weakness with Basel II. At the heart of the financial crisis, after all, was banks investing in highly-rated debt backed by lousy mortgages. This is all absolutely true, but at the same time a sovereign default is always going to cause a banking crisis, no matter what kind of capital-adequacy rules are in place.
In part because they could plausibly argue that it was risk-free or nearly risk-free… If the exposure was classified as market risk rather than credit risk, the Basel II framework was based on Value-at-Risk, which showed very low volatility. In other words, the regulatory framework was pushing banks hard in the direction they were already going: But if a bank with a big derivatives book does end up declaring bankruptcy, the effects can still be catastrophic.
Even if that were a good idea.An Academic Response to Basel II Executive Summary It is our view that the Basel Committee for Banking Supervision, in its Basel II proposals, has failed to address many of the key deficiencies of the global financial regulatory system and even created the potential for new sources of instability.
FINS Chapter 2 Essay by billy1benntt in Types > School Work and fins chapter 2 essay What is the minimum capital requirement under the Basel II capital accord? Outline some of the strengths and weaknesses of VaR models and briefly explain why regulators have moved to implement a ‘stressed VaR’ requirement for Australian.
To avoid a reoccurrence of a financial crisis with that expansion and to protect the human beings from its withdrawals the committee of Basel decided to reform the Basel II and to upgrade it to a stricter system with more regulations on the market.
Strengths, Weaknesses, Successes, and Failures of the Articlesof Confederation Free Essay, Term Paper and Book Report The Strengths, Weaknesses, Successes, and Failures of the Articles of Confederation Congress adopted the Articles of Confederation, formally known as the Articles of Confederation and Perpetual Union, on November 15, Strengths- Sincere, Honest, Integrity, Trust Worthy.
Weakness- I always try for quality output, which some times hampers / delays / effects the speed of my work.
Beginningnew Basel III capital requirements following the original Basel II rules require banks to fund themselves with % of common equity (up from 2% in Basel II) of risk-weighted assets (RWAs).Download