In designing the new Basel framework, Basel III, the close interlinkages in the financial system – between sectors as well as between jurisdictions – have to be taken into account in order to prevent regulatory arbitrage.
This is because the new capital and liquidity standards for banks will not only lead to an increase in the quality and quantity of capital and an improvement in liquidity. At the same time, these more stringent regulations will potentially set incentives to shift transactions and thus circumvent the stricter banking regulation.