Moreover, liquidity supervision and regulation have failed to keep up with banks’ changing risk profiles and growing vulnerability to market-based shocks. All in all, these issues underscore the need for Basel II and the necessity to continuously improve the framework. Recent difficulties also highlighted the lack of transparency due to insufficient disclosure. CDOs of asset-backed securities are a particularly striking example.
I must add, however, the turmoil also made clear that investors did not make full use of available information and placed excessive reliance on external ratings. Taken together, these factors resulted in banks and investors assuming excessive risk and concentration to the subprime sector – either directly or indirectly through structured products based on subprime mortgages.