Bank Regulation: Basel II & Financial Crisis (2008-2009)

In my last blog, I addressed the overview of the framework of Basel II and its updates. This Accord experienced a serious challenge occurred from mid-2007 to 2009.

Do you remember? Mortgage backed security, credit risk, Lehman Brother’s bankruptcy, acquisition for Merrill Lynch and nationalisation of Northern Rock, etc. That was the worldwide financial crisis which erupted in American sub-prime loan’s sector and result in the global financial system collapse. Shown with its weakness, Basel II—the capital based regulation—was into the spotlight and blamed by lots of people such as ‘economists, policy-makers and market operators’. What responsibilities related to financial crisis might be imputed to Basel II? (Cannata and Quagliariello, 2009)

Figure 2: Responsibilities of Basel II in the Financial Crisis (referenced GuiltyRole?)

Moosa (2010) also exposed Basel II’s weaknesses and how they were exposed by the financial crisis. Generally, two prominent roles it played as, which were ‘providing the wrong kind of regulation and ignoring liquidity and leverage’.  The ‘exclusionary, discriminatory and one-size-fits-all’ Accord did not cope with the sub-prime financial crisis due to it could not bear all responsibilities well, for instance, applying bank internal models.

Caruana and Narain (2008) argued that ‘Basel II does not address all the regulatory issues that figure in the lessons learned from current market events’. Indeed, the regulation was abandoned. Moreover, Coy (2008) pointed out the committee should be responsible for the dysfunctional outcome. ‘The bureaucratic machinery of Basel II could become a classic case of the law of unintended consequences’. The committee absorbed members from seven new countries. Consequently, in response to this crisis, the enlarged BCBS the members published new standards—Basel III in 2010.