Regulatory Failure and the Global Financial Crisis

Regulatory Failure and the Global Financial Crisis

An Australian Perspective

Edited by Mohamed Ariff, John H. Farrar and Ahmed M. Khalid

This fascinating book presents a lively discussion of key issues resulting from the recent financial crisis. The expert contributors explore why the global financial crisis occurred, how it destroyed wealth, triggered mass unemployment and created an unprecedented loss of control on employment, monetary policy and government budgets.

Chapter 4: Bank Capital Adequacy: Where to Now?

Kevin Davis

Subjects: economics and finance, financial economics and regulation


Kevin Davis 4.1 INTRODUCTION The use of minimum (risk weighted) capital requirements has been an important plank in banking regulation for the last two decades, following the release of the first Basel Capital Accord in 1988. Since that time, there have been various modifications to the Basel framework, and a comprehensive revision (Basel II) was produced in 2006 with many countries, such as Australia, commencing introduction one or two years later. Coincidentally, the introduction of the Basel II framework came very close to the time of the onset of the Global Financial Crisis in mid-2007, with numerous banking failures and difficulties globally. Even though Basel II was yet to have a significant effect,1 the GFC experience has led to a rethinking of approaches to capital regulation and numerous proposals for changes to that framework (as well as more wide-ranging questioning of the appropriate degree and scope of financial sector regulation). Among those proposals are suggestions for: the use of a (non-riskweighted) leverage ratio as an adjunct to the Basel II risk-weighted capital requirement; contingent capital requirements; countercyclical capital buffers; higher quality capital; a higher quantity of capital; capital maintenance (dividend restriction) requirements; and changes to regulatory risk weights. To assess the merits of these proposals, and possible effects, it is important to clarify the concept of bank capital, and that is done in section 4.2 below. It is also useful to trace briefly the history of capital requirements and bank capital experiences during the GFC. Thus section 4.3 reviews...

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