Policy Documents

Regulation of Bank Capital and Liquidity

Shadow Financial Regulatory Committee –
December 10, 2012

The conceptual approaches to prudential regulation embodied in the Basel III and the U.S. approaches suffer from fundamental deficiencies that require remediation. These deficiencies include (1) relying upon fixed risk weights for measuring risk-based capital that are arguably inaccurate, 2) relying upon fixed weights that, even if initially measured properly, inevitably will be wrong as market conditions change and will invite increased risk taking that misallocates banking resources, (3) constructing increasingly complex formulas used to measure liquidity in the new requirements, which are not sufficiently grounded in a sound conceptual framework, and that give a false impression of precision and adequacy, (4) establishing capital adequacy standards that are too low relative to either total assets or to any proper definition of risk-weighted assets, and (5) failing to institute any actions that address the problems of regulatory and institution forbearance that tend to result in a failure to promptly measure and respond to asset losses and capital impairment.