Basel Accords: How Banking Regulation Creates Crises Instead of Preventing Them

The Basel Accords are not a shield for the global financial system, but a Trojan horse that bankers have driven into the heart of the global economy to applause from regulators.

Imagine a fire department that instead of extinguishing fires, surrounds a burning house with bureaucratic prescriptions about what brand of fire extinguisher should be used. That's roughly how the Basel Accords work — an international framework of banking regulation that supposedly prevents financial crises, but in reality only creates an illusion of control over chaos.

Since the signing of the first Basel Accord in 1988, the world has experienced more banking crises than in all previous human history. Coincidence? Hardly. When regulators start playing god with financial markets, markets start playing hide-and-seek with regulators — and always win.

But the most interesting thing is not that these accords don't work. The most interesting thing is that they work exactly in reverse: instead of reducing systemic risk, they concentrate it, package it, and send it under the Christmas tree of the global economy as a gift with a timer.

History of Failures: From Basel I to the 2008 Collapse

Basel I appeared in 1988 as a response to the Latin American debt crisis. The idea was simple to the point of genius: let's force banks to hold more capital — and everything will be fine. The capital adequacy ratio became the sacred cow of regulators, a mantra they repeated like Tibetan monks.

The problem turned out to be that bankers are not fools. When they were told that certain assets require more capital, they simply started wrapping toxic assets in the pretty packaging of securitization, got high ratings from agencies (which, by the way, were paid by the same banks), and voilà — toxic garbage turned into "safe" assets with minimal capital requirements.

Basel II, adopted in 2004, was supposed to fix these "shortcomings." Instead, it legalized banks' use of their own risk assessment models. It's like allowing students to grade their own exams. The result? By 2008, the world's largest banks formally complied with all Basel II requirements while simultaneously sitting on a bomb of subprime mortgages that exploded and took trillions of dollars with it.

Lehman Brothers before bankruptcy had a capital adequacy ratio exceeding minimum requirements. Bear Stearns — too. The entire Icelandic banking system formally complied with Basel II. So what? They collapsed like houses of cards because regulatory ratios turned out to be as real as unicorns and politicians' honesty.

Basel III: Bureaucratic Security Theater

After the 2008 crisis, regulators did what they always do: doubled down on a losing strategy. Basel III was born — a real monster of 509 pages of rules, amendments, ratios, and exceptions to exceptions.

Now banks must not only maintain a capital adequacy ratio but also monitor the leverage ratio, liquidity coverage ratio (LCR), net stable funding ratio (NSFR), countercyclical buffers, systemic importance buffers, and a dozen other metrics whose names sound like spells from Harry Potter.

The result? Banks hired armies of compliance officers who spend their time filling out endless reporting forms for regulators. By some estimates, large banks spend 10% to 15% of their operating expenses on regulatory compliance. That's billions of dollars that could have gone to lending to the real economy, but instead go to creating beautiful reports that nobody reads.

But the most amusing thing is that Basel III created a new category of "systemically important banks" (SIFIs) that are "too big to fail." Essentially, regulators officially acknowledged: yes, there are banks we will bail out no matter what, because their collapse will bring down the entire system. Guess what happened next? Right: these banks started behaving even more recklessly, knowing that taxpayers would backstop them.

This is called moral hazard, and Basel III not only didn't solve this problem — it legalized it, stamped it, and handed out "systemic importance" certificates. Imagine giving a teenager with a driver's license a Lamborghini and saying: "Drive as you want, if you crash — parents will buy a new one." What will happen? The same thing happens with banks.

Systemic Risk as a Byproduct of Regulation

Here's a paradox that regulators stubbornly refuse to acknowledge: the more unified the rules become for banks, the more correlated their risks become. Basel Accords force all banks to look at the same indicators, use the same risk assessment models, hold the same types of assets.

What happens when everyone plays by the same rules? Everyone does the same thing. When the market goes up — everyone buys. When it falls — everyone sells. It's like forcing all traffic participants to move at the same speed and brake at the same moments. One person's accident turns into a massive pile-up.

Basel requires banks to hold more government bonds because they're considered "safe assets" with zero risk. Seriously? Greece, Argentina, Lebanon — all these countries defaulted on their bonds in the last 20 years. But according to Basel rules, their bonds were considered safe... until the moment of default.

The result — banks around the world hold mountains of government debt, creating a vicious circle: governments print money and go into debt, banks buy these debts (because Basel told them to), and when the state starts sinking, banks sink with it. This is not systemic risk reduction — it's concentration and amplification.

Diversification is the foundation of risk management. But Basel Accords create the opposite effect: they force all banks to gather in one corner of the room, holding hands and hoping the floor won't collapse. Spoiler: it will. And when it happens, everyone will fall at once.

Adequacy Ratios: Statistical Illusion

The problem with any ratios is that they give an illusion of precision where it cannot exist. Banks calculate capital adequacy ratios to the second decimal place, as if it means something. "We have a CET1 ratio of 12.3%!" — the bank proudly declares. And a year later it goes bankrupt.

Why? Because all these beautiful numbers are based on risk assessment models that work perfectly... when everything is fine. When a crisis begins, these models turn into pumpkins at exactly midnight. They're built on historical data and assume the future will be like the past. But crises are crises precisely because they're unlike the past.

Take risk-weighted assets (RWA) — the central concept of Basel. A bank can hold 100 million in government bonds with a 0% risk weight and 100 million in corporate loans with a 100% risk weight. Guess what the bank will prefer to do? Right: buy government debt because it doesn't require capital.

The result — lending distortion. Small and medium-sized businesses that create jobs and move the economy get fewer loans because it's more profitable for banks to finance governments. And then economists wonder why economic growth is so sluggish.

And one more dirty secret: banks manipulate these ratios with such ease that it has become an art form. Temporarily sell assets at the end of the quarter to improve indicators, then buy them back. Use derivatives to "optimize" balance sheets. Regulators see this, nod their heads, and pretend everything is under control.

Zombie Banks: When Regulation Strangles the Economy

The most insidious consequence of Basel Accords — the appearance of zombie banks. These are banks that by all Basel metrics look alive but are essentially dead. They don't lend to the economy, they just exist, supported by artificial respiration of central banks' cheap money and regulatory forbearance.

Japan is a classic example. After the crisis of the 90s, Japanese regulators, following the spirit of Basel, didn't let banks go bankrupt. Instead, banks existed in suspended animation for decades, not writing off bad loans, not lending to new projects, creating a "lost decade" that turned into three lost decades.

Europe is following the same path. The European Central Bank, as part of "prudential supervision," keeps from bankruptcy banks that should have closed long ago. Why? Because their collapse would reveal that the entire system is not as stable as Basel ratios claim.

This creates a vicious circle: weak banks absorb resources, preventing the strong from developing. Innovation is stifled, risks are frozen, economic growth is paralyzed. Basel regulation has turned a dynamic financial system into a bureaucratic swamp where not the best survive, but those who best know how to fill out forms.

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