Excessive risk-taking by large banks was among the main causes of the 2008–09 financial crisis. This column argues that the antidote to excessive risk-taking should come from the elimination of the subsidies of the banking charter and the implicit promise of bailout in case of major losses, and the introduction of strong incentives for management and shareholders to preserve the capital of their bank. This requires deep changes in Basel prudential rules.
Excessive leverage and risk-taking by large international banks were among the main causes of the 2008–09 financial crisis and the ensuing sharp drop in economic activity and employment. Enormous costs were borne by taxpayers and societies at large. In reaction, world leaders and central bankers undertook to overhaul banking regulation, including by rectifying the failed Basel prudential rules with the new Basel III Accord. Many scholars have commented on the proposed reforms, especially the US’s Dodd-Frank Act (eg Acharya and Richardson 2011).
Europe is now considering how to transpose the new Basel III Accord, with the proposed Capital Requirements Directive IV, now before the European Parliament and Council. In our study published last week (Carmassi and Micossi 2012) we argue that these reforms are not enough; they fail to correct the three critical shortcomings of Basel prudential rules, namely:
- Reliance on banks’ risk management models for the calculation of capital requirements.
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