Credit evaluation, capital adequacy and asset price inflation: Key issues for prudential regulation after the global financial crisis

Transaction Publishers
Publication Type:
Journal Article
International Journal of Applied Economics and Econometrics, 2010, 18 (4), pp. 29 - 57
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Mostihnalyses of the global financial crisis to date have focused on analysing specific features of the 'Crisis including sub-prime loans defaults, the role of structured i~estrnent vehicles, defici~ncies in the performance of credit rating agencies and the reaction of financial losses sustained on account of these forces. Less attention has been paid to the~c1imate of asset price inflation within., which sub-prime loans were written although increasing , ~ttention has been paid to the regulatory responses. required by the crisis. Th~s paper briefly surveys the theory of financial system functions and prudential regulation, and cqnsiders the implications of this theory for ,understanding the causes of the crisis and the , shape that prudential regulation should take in the light of the crisis. It'argues for the establishment of an independent, public credit rating agency and for the financial system to be regulated functionally, with any entity that issues shorfterm securities (or deposits) against " the holding of risky loans being made subject to Basel II capita1 requirements. It also argues that these requirements be made variable for loans used to finance key assets. in order to reduce the possibility of asset price inflation.
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