Sunday, March 21, 2010

Why Basel is Mr Faulty

A neat illustration that young bright stars are still capable of inspiring progress comes from Anna Katherine Barnett-Hart, a BA hons student at Harvard in her hons dissertation which charts the CDO meltdown in simple English without academic pretension or vast quantities of Greek symbol ego.

The findings are obvious enough but some of the implications are apposite.

One is that Basel type regulatory rules (which dictate the levels of capital to be held by banks) generate perverse outcomes. The more equity capital Basel types demand of banks, the greater is the incentive to move debt capital off the balance sheet – into SPV (special purpose vehicles) or SIV structures (structured investment vehicles) whence CDOs and the like may be sold.

This sort of regulation is utterly counterproductive then – and we have just implemented Basel II here and the RB is at present examining capital adequacy ratios in a tightening process.

The thesis may be read here.

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