Emerging problems with the Basel Capital Accord: Regulatory capital arbitrage and related issues

Abstract

In recent years, securitization and other financial innovations have provided unprecedented opportunities for banks to reduce substantially their regulatory capital requirements with little or no corresponding reduction in their overall economic risks - a process termed "regulatory capital arbitrage". These methods are used routinely to lower the effective risk-based capital requirements against certain portfolios to levels well below the Basel Capital Accord's nominal 8% total risk-based capital standard. This paper discusses the principal techniques used to undertake capital arbitrage and the difficulties faced by bank supervisors in attempting to deal with these activities under the current capital framework. © 2000 Elsevier Science B.V.