Edited by Thorsten Beck - Vox

7. Are the changes under Basel III sensible?
The Future of Banking
a. First and foremost, the systemic risk weights seem arbitrary and are not based
on objective criteria. Thus, across-the-board higher capital requirements, as are
being proposed for systemically important financial institutions, may actually
exacerbate the problem. Regulation should not be about more capital per se but
about more capital for systemically riskier financial firms.
b. Second, our methodology makes clear that higher capital requirements resulting
from systemic risk do not have to coincide with larger financial institutions.
For a variety of reasons, it may well be the case that large financial institutions
deserve heightened prudential regulation. But if the criterion is that they need
sufficient capital to withstand a crisis, it does not follow that size necessarily is
the key factor unless it adversely affects a firm’s marginal expected shortfall,
ie its performance in a crisis.
c. Third, it is certainly the case that a bank’s return on equity does not map oneto-one
with a bank’s valuation. A higher return on equity might simply reflect
higher leverage on the bank’s part, and the benefit of leverage may be arising
from the government safety net. Therefore, calling for a higher equity capital
requirement may be sensible. That said, there seems to be little economic
analysis of what the right level of capital should be.
d. Finally, whatever is being proposed for the banking sector in terms of capital
requirements should have comparable regulation for the shadow banking
sector, lest the activities simply be shifted from one part of financial markets to
another. The result of such a shift could actually lead to an increase in systemic
risk.
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