International Finance Regulation: The Quest for Financial Stability

CHAPTER 5 Capital Adequacy, Liquidity, and Leverage Ratios: Sailing toward the Basel III Rules

“Specific policies to counteract the structural vulnerabilities created by short-term wholesale funding are a priority, not just for the stability of our large prudentially regulated institutions, but for the financial system as a whole.”

—Federal Reserve Governor Daniel K. Tarullo

As markets became more global, the temptation was huge for some countries to use weak domestic regulation as a way to compete in the global financial arena. Competitive regulation had to be addressed at a global level and key stability ratios could not be left to national regulation.

But it is also fair to say that there remains no clear consensus on the balance to be struck between international (whether global or European) and national regulation. Faced with domestic political critics, governments and regulators have worked on their own bespoke responses, which may well complicate the task of achieving stronger international coordination.¹

Besides the competitive aspect, there is a more substantial risk. If some countries develop weak stability ratios, they become more vulnerable to a banking crisis. The interconnectedness of the financial system creates an immediate contagion. It is therefore essential for the development of a more stable financial environment that the banking community adopts the same rules and criteria for adequacy of their balance sheets (see Figure 5.1).²

FIGURE 5.1 The Three ...