Operational Risk toward Basel III: Best Practices and Issues in Modeling, Management, and Regulation

CHAPTER 20

Actual and Potential Use of Unregulated Financial Institutions for Transnational Crime

Carolyn Vernita Currie

 

 

ABSTRACT

The problems of hedge funds, mortgage brokers, and finance companies have several common themes: a lack of prudential supervision; an ability to evade anti-money-laundering legislation using cross-border transactions; regulators using a common escape clause of “natural market forces”; and benefits accruing to the originators. In view of the potential of these types of nonbank financial institutions (NBFIs) to generate systemic crisis by avoiding the new operating risk requirements of Basel II, the effectiveness of the new capital adequacy regime is now highly questionable. By offering a regulatory black hole, unregulated NBFIs appear to have become the home of the new transnational criminal.

20.1 HISTORY OF THE SUBPRIME CRISIS AND THE ROLE OF HEDGE FUNDS, FINANCE COMPANIES AND PLANNERS, AND MORTGAGE BROKERS

According to a recent analysis (Pennington 2007), the subprime mortgage crisis in the United States had its roots in operational risk (OR) problems. Although credit risk played a significant role, Pennington (2007) defines subprime mortgages as loans to consumers with low credit scores at higher interest rates than prime credits.¹ She claims that the high rate of default made in the first eight months of the loan’s life is not just due to bad credit risk factors but totally to OR factors such as:²

1. An influx of mortgage lenders during ...