If effective, the new and still evolving capital adequacy requirements can go a long way to reduce incentives to take excessive risks across different banking operations and the use of excessive leverage. Most obviously, higher capital requirements provide for more loss absorbency. Liquidity requirements can also reduce banks’ interconnectedness by restricting the use of short-term market funding.
They will also be helpful in reducing excessive leverage and building liquidity buffers. The new capital requirement framework also reduces complexity and interconnectedness by blocking opportunities for regulatory arbitrage which previously was possible via complex securitisation structures. Recovery and resolution regimes aim to create a framework which did not exist at EU level prior to the crisis.