Sunday, November 23, 2008
Bank crashes and the Basel Accords
I need information and understanding - please help me, somebody.
I've pointed out more than once that M4 bank lending in the UK accelerated from 2003 on, and I suspected it was something to do with reducing bank capital adequacy requirements, so the government (via its regulators) would have been implicated. In other words, I've been looking for the villain of the piece, and the smoking gun.
But do you think I can find them?
What I have found so far is references to the Basel Accords, Basel I and Basel II. Basel I became law in the G10 countries including the UK in 1992, and Basel II was published in 2004. The general drift, I understand, is to encourage a uniformity of approach to systemic financial risk, and to introduce a system of risk-weighting bank capital according to what the banks are lending against or investing in. What a success that has proved! Perhaps we should refer to the scheme as "Basel Fawlty".
But can somebody help unpack and simplify what actually happened? Is it, for example, possible that this system was perceived by the banks as a more pliable alternative to fixed minimum reserve ratios, and so they reduced the cash in their vaults to the very least that they could tweak the definitions? For example, we have read many times how mortgage-backed securities are at the heart of the subprime problem, because the packages could be represented as having much less risk than they actually contained.
So is the present crisis an unintended consequence of more elastic international regulation, dating back as far as the early 1990s?