Crashed: How a Decade of Financial Crises Changed the World

by Adam Tooze

The obvious inadequacies of Basel I set in motion the search for a new framework that finally emerged in 2004 with the Basel II accord. But the transition from one regime to the other was telling. Whereas Basel I had been a conventional regulation aiming to impose standards on the industry from the outside, the chief ambition of Basel II was to align risk regulation with “best business practice” as defined by the bankers themselves. Basel II did require off balance sheet risks to be brought onto the banks’ own accounts. But at the same time, they were encouraged to apply their own risk-weighting models to those assets to decide how large their capital buffer needed to be. Far greater reliance was placed also on the credit evaluations issued by the private credit rating agencies.40 Though Basel II notionally maintained the 8 percent capital requirement, once the big banks applied their proprietary risk-weighting models, they found that they could sustain larger balance sheets than ever before. Under Basel I mortgage assets had been rated as relatively safe and counted only 50 percent for purposes of calculating the necessary capital. Rather than tightening those regulations as a way of moderating the real estate boom, Basel II cut the capital weight of mortgage assets to 35 percent, which made it far more attractive to hold high-yielding mortgage-backed assets.41 Precisely as the private label securitization boom was about to accelerate, the regulations lightened.