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Reconsidering Bank Capital Regulation

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Reconsidering Bank Capital Regulation

A New Combination of Rules, Regulators, and Market Discipline

IMF,

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This blueprint for improving bank capital regulation could prove to be the vaccine against bank failures.

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Editorial Rating

8

Qualities

  • Innovative

Recommendation

The 2008 financial crisis and other instances of bank failures testify to the fact that the supervision of banks’ capital requirements has hazardous shortcomings. Duke economics professor Connel Fullenkamp and IMF economist Céline Rochon make a robust case for simpler rules, empowered regulators and greater market discipline that would eliminate a one-size-fits-all approach. However, their arguments place great faith in the same regulators who have been found lacking time and again. Although this IMF report doesn’t refer to regulators’ most important function – ensuring that banks use their capital appropriately to fuel economies – getAbstract recommends this analysis as a necessary read for bankers, policy makers and those responsible for keeping the global banking system stable.

Summary

The Response to the Crisis

The financial crisis that spread rapidly across the globe in 2008 highlighted a number of inadequacies in the way national supervisors regulate banks. Despite previous warnings, regulation did little to rein in too-big-to-fail organizations. While the Basel accords mandated capital standards that many considered adequate to cover the risks a bank might face, banks still managed to leverage enormous exposures by using complex over-the-counter derivatives and by manipulating their asset risk weightings.

Given how futile bank regulation proved in the face of a major crisis, it’s no wonder governments around the world established numerous commissions that issued copious reports advocating for a plethora of new laws. Enacting more rules allows politicians to show that they are addressing the issues, but it isn’t necessarily the most effective strategy. Policy makers often overlook the option of enhancing regulatory supervisors’ accountability and, instead, increase the rules on banks, which have proven adept at circumventing regulation.

Current Shortcomings

Regulators may think they are covering all the bases by setting new rules...

About the Authors

Connel Fullenkamp is a professor of economics at Duke University. Céline Rochon is a senior economist at the IMF Institute.

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