Risk that banks liquidating buffers to meet outflows in a stress could exacerbate a fire sale. Less effective Mitigants RWCR: Susceptible to expansion into assets with low measured risk. Places no constraint on debt funding. LCR: 30 day time horizon only limits the expansion funded by very short term liabilities. RWCR & LR: Higher capital should in principle help banks retain funding, but does not provide a cushion if a run occurs. RWCR & LR: Require small fraction of liabilities to be non-runnable equity but a small amount relative to illiquid assets. RWCR & LR: Do not directly mitigate the likelihood of deleveraging due to liquidity problems. Capital and Leverage  The objective of the capital framework is to ensure banks have sufficient capital to absorb unexpected losses and continue lending in situations of stress. RWCRs oblige banks to assign granular risk weights to their assets. If true risk of an asset can be estimated accurately – it is a “known known” - then the RWCR is typically better suited than the LR to guarding against solvency risk (Gordy (2003)). Greenwood et al (2017) conclude “the social optimum can be implemented with a single requirement that each bank maintain a sufficient ratio of equity to risk-weighted assets, provided the risk weights are chosen appropriately”. The last part of this sentence is, however, an important proviso. One key question is whether risks in the financial system are likely to be known with sufficient certainty that they can be estimated meaningfully and accurately.
The Securities and Exchange Commission’s Report to Congress contains a detailed assessment of the impact of Basel III and the Volcker Rule on liquidity in US Treasury and corporate debt markets (SEC (2017)). 15  All speeches are available online at www.bankofengland.co.uk/speeches  15  risk-weighted assets (Bank of England (2015c)). Table 1: Overall Implications of Research Findings for Optimal Capital Impact on optimal capital: Benefits: Likelihood and severity of crises Impact of capital on probability of crises Impact of capital on severity of crises Impact of TLAC and resolution regimes on prob. and severity of crises Costs: Impact of capital on credit conditions and growth Impact of capital on market liquidity (leverage ratio) in normal conditions  The System of Financial Regulation  Regulatory reform has tended to progress crisis by crisis, market failure by market failure, regulatory standard by regulatory standard. This is not especially surprising, given the nature of the policy design process. Nonetheless, if we put together the various pieces of recent regulatory reform, we find a fundamentally different regulatory jigsaw, or system of financial regulation, than in the past. One important dimension of that new architecture is the significantly larger number of regulatory rules or constraints that now operate. On top of risk-based capital standards have been added regulatory rules for liquidity, leverage and loss-absorbing capital. In other words, we have moved from a system of largely uni-polar regulation to multi-polar regulation (Haldane (2015)).