To take one example, large, complex banking organizations now routinely structure their portfolios in ways that arbitrage around the current capital standard. These banks can often lower their capital requirements with little, if any, reduction in their actual risk-taking. As a result, reported capital ratios may – and too often do – overstate a bank's true financial strength.
Thus we need a capital framework that is more risk-sensitive and compatible with current market practice. Absolute levels of capital must be consistent with risk in order not to shift risk-taking either away from or to banks, but we also need a standard that better reflects relative levels of risk. Identifying and correctly measuring relative risk is critical for avoiding capital arbitrage.