BACK TO THE FUTURE? FROM BASEL III TO BASEL II Fernando J. Cardim de Carvalho Institute of Economics Federal University of Rio de Janeiro Rio de Janeiro,

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BACK TO THE FUTURE? FROM BASEL III TO BASEL II Fernando J. Cardim de Carvalho Institute of Economics Federal University of Rio de Janeiro Rio de Janeiro, 23 and 24 August, 2011

Basel II Hailed as evolution compared to B I More precise treatment of credit risks Market-friendly: based on markets’ best practices in risk measurement (inducement instead of compulsion; working through private financial practices) Role for market discipline

But also criticisms Pro-cyclicality (Goodhart) Complexity (“ridiculous” according to head of OCC) Too prescriptive (Barth, Caprio, Levine) Emphasis on risk measurement Difficulties in measuring credit risk Weight of operational risk on total capital charges

Cont. Excessive demands on Supervisors Underestimation of many risks, including liquidity (left to pillar II) Systemic risk as an externality: cannot be internalized Values and parameters to VaR are not given: they change with banks’ behavior

Basel III Narrower definition of capital for regulatory purposes: redefined tier I (from inducement to prudence to sharing the burden) Tougher on securitization and ressecuritization Rising capital requirements Leverage ratio Interaction between classes of risk

Cont. Liquidity risks (market and financing) Stress tests (normal and abnormal) Feedback effects (eg mark to market) left to pillar II Anti-cyclical and anti-systemic risk buffers Higher demands on systemically important institutions

Some Assessment Minskyian concerns? Rediscovery of concern with liquidity, but measurement problems remain; Leverage ratio. Capital requirements: how much is enough? Insistence on risk measurement as regulatory concern: maintains principle that systemic safety is maintained through private perceptions and measurements of risk

Cont. Systemic risk: consider interrelations: how? Concept of systemically relevant Endogeneity of parameters in VaR models Role of rating agencies maintained