Thesis_gd_final_vers.. - Vernimmen

not have been profitable if they had to be financed with a capital requirement of 8%. Thus, the
consolidation of conduits for regulatory matters would have discouraged banks to set them up in
the first place. Regulatory arbitrage is not limited to by-passing regulatory capital requirements by
playing on the difference between on and off-balance sheet. Referring to Acharya and Schnabl
(2009), Nadauld and Sherlund explain that between 2004 and 2007 the growth in risk-weighted
assets was much lower than the growth in total assets, which means that banks have been
investing in safer assets than those which they were holding during this period. When we know
that banks kept as much as 30% of the AAA-rated tranche of all real estate related ABS and
CDOs on their balance sheet, it is easy to understand that banks used securitization as a way to
free-up additional regulatory capital, or let’s say to take on more risk for an equal level o regulatory
capital. This form of regulatory arbitrage is based on the rating arbitrage presented above to
decrease regulatory capital requirements. Exposure to assets which would have require higher
capital levels given their risk are actually hold through the AAA-rated tranche of the ABS, which
requires less regulatory capital. This regulatory arbitrage can be viewed as based on the use of
asymmetric information by banks on the true riskiness of their assets against regulators.
d) The development of financial markets and derivatives
The limitations and restrictions imposed from early on on banks, limiting their size and scope and
thus their ability to support and finance companies which have been getting larger over time, has
fostered the development of broad and active capital markets which are a major source of
financing for the economy. In his book U.S bank deregulation in historical perspective, Calomiris
(200) underlines that a key characteristic of the American universal banking model is the growing
integration between commercial banks and financial markets. According to him, leveraging and
using the comparative advantage of US financial markets will be one of the drivers of success for
US commercial banks in the first decades of the twenty-first century. If it is true that US financial
markets have been more developed and active than in other countries, they also experienced a
tremendous growth thanks to technological changes which have allowed to reduce transaction
costs, to compute data and disperse information instantly. Financial innovation reinforced and was
reinforced by technological change. As a consequence, financial markets scope is increasing at a
very high pace thanks to the creation of new products such as complex derivatives. The latest
example is doubtlessly the extraordinary growth of credit derivatives and especially credit default
swaps. The notional amount of credit default swaps stood at $698 billion at the end of June 2001;
- 22 -