The turmoil in world financial markets, triggered by defaults on subprime mortgages in the US, raises questions about macroeconomic policy, financial stability and the design of financial regulation, including the new Basel II capital adequacy framework for banks.
The implementation of Basel II coincides with massive losses reported by some of the world’s largest banks, requiring large-scale recapitalisations. The risk models that anchor Basel II are, to a large extent, the same as the ones many of these banks have been using in recent years. Sheila Bair, chairman of the Federal Deposit Insurance Corporation in the US, has noted that these models have important weaknesses which, in the light of recent market turmoil, are a flashing yellow light to drive carefully.
