The missed opportunity and challenge of capital regulation

| Publication date: 3 Feb 2016 | External Author(s): Admati, A R | JEL Classification: G21, G28, G32, G38, H81, K23 | Journal: National Institute Economic Review Issue 235 | Publisher: Sage Publications, London

Capital regulation is critical to address distortions and externalities from intense conflicts of interest in banking and from the failure of markets to counter incentives for recklessness. The approaches to capital regulation in Basel III and related proposals are based on flawed analyses of the relevant tradeoffs. The flaws in the regulations include dangerously low equity levels, a complex and problematic system of risk weights that exacerbates systemic risk and adds distortions, and unnecessary reliance on poor equity substitutes. The underlying problem is a breakdown of governance and lack of accountability to the public throughout the system, including policymakers and economists.

Keyword tags: 
banking regulation
capital regulations
equity in banking
capital structure
agency costs
leverage ratchet effect
risk weights