This framework mainly contains five central elements: The first is the strengthening of the quality and quantity of bank capital, and a harmonisation of the calculation of regulatory capital across jurisdictions. Better and higher bank capital is needed in order to foster the loss-absorbing capacity of banks. To this aim, Basel III increased the minimum common equity Tier 1 (CET1) ratio from 2% to 4.5% of risk weighted assets. The second is the requirement for banks to build-up buffers above the required minimum, particularly when the economy is booming, thereby providing for additional cushions to absorb losses in periods of financial distress.2 In addition, further buffer requirements are foreseen for systemically important financial institutions (SIFIs) as well. The third element is directed to enhance the “risk coverage” of the regulatory framework, providing a more comprehensive treatment of banks’ exposures to complex financial products whose risk to the system has been neglected so far. The fourth element is the adoption of a simple and transparent rule to prevent the excessive reliance on debt by the banking sector. And last, but not least, the new framework intends to improve banks’ resilience to liquidity shocks and to increase market confidence in the liquidity position of banks. The intended improvements in the liquidity position of banks aim at containing the excessive reliance on short-term funding and give incentives to hold safe and liquid assets.
As Raguram Rajan summarized in his book “Fault Lines”: “The financial sector is, in many ways, the brain of a modern economy. When it functions well, it allocates resources and risk effectively and thereby boosts economic growth. [...] It works for all of us. Of course, when it works poorly, as has done recently, it can do enormous damage while befitting a very few.”12 Part of the failures was certainly attributable to deficiencies in financial regulation and supervision. The regulatory overhaul of the financial sector is intending to correct this and thus help the financial sector to refocus on its servicing role. 10  See Schumpeter, J.A. (1934), “The Theory of Economic Development: An Inquiry into Profits, Capital, Credit, Interest and the Business Cycle”, Harvard University Press. 11  For this list of functions see Levine, R. (2005), “Finance and Growth: Theory, Evidence, and Mechanisms”, in P. Aghion and S. Durlauf (eds), The Handbook of Economic Growth, North Holland. 12  See Rajan, R.G. (2010), “Fault Lines”, Princeton University Press. 6  BIS central bankers’ speeches    Strengthening of bank capital and liquidity standards,    addressing systemically important financial institutions,    improving over-the-counter infrastructures,    and a reform of compensation practices, that I mentioned before,    these are all important elements in this process. derivatives  markets  and  core  financial  market  At the same time, regulatory reforms themselves require regular revaluation.