Asset Securitization, Regulatory Capital Arbitrage And Bank Capital Regulation

As a financial innovative tool, the initial aim of asset securitization, which is originated in 20th century,70 years of U.S. financial markets, is to meet the U.S. housing mortgage market liquidity needs, and solve the funding constraints that the lending banks face. Basel accord of 1988 inspired the international bank regulatory capital arbitrage, and asset securitization is the most important methods and techniques for bank regulatory capital arbitrage. Regulatory capital arbitrage refers to the behaviors that banks evade regulation through the innovative asset securitization and make "cosmetic" adjustments to boost their reported capital ratios, which result from saving of regulatory tax:the gap between economic capital and regulatory capital.The behavior of international banks regulatory capital arbitrage by asset securitization has brought great impact to the capital regulation. The result of the regulatory capital arbitrage is that the core indicators of capital adequacy for regulatory can not effectively monitor the bank’s ability to resist risks. Facing the prevailing regulatory capital arbitrage, the Basel committee issued the new capital accord in 2004, including the asset securitization framework. However, the regulatory for asset securitization under the framework did not shake the internal mechanism of regulatory capital arbitrage which is the expansion of the loan size and risk amplification. The repeated behavior of bank asset securitization caused the mortgage balance of the whole society increasing and the credit risk accelerating through the mode of "create loan—sell loan—create loan—sell loan". Huge systemic risk formed in the end. The existing capital adequacy ratio indicator can not reflect the bank’s ability of resisting risks. When the economic environment changes, the crisis begins from the weak link in financial markets, and then spreads to the financial system, and damages the real economy finally. The U.S. financial crisis in 2007 powerfully proves the regulatory capital arbitrage by asset securitization led to the failure of bank capital regulation.Facing the financial crisis, the global financial regulatory reform is imperative. The Basel Committee proposed Basel III in 2010. From the failure mechanism of the regulatory, we can see that the current static capital adequacy ratio can not control risk, and we must establish dynamic capital adequacy ratio to prevent bank regulatory capital arbitrage.Based on the above ideas, this paper first describes a variety of regulatory capital arbitrage models and their comparative analysis, followed by brief introduction of the evolution about regulation on asset securitization. All the regulations do not consider the micro-mechanism of asset securitization of regulatory capital arbitrage. Therefore, we should focus on the internal mechanism of asset securitization which leads to failure of the capital regulation. Five propositions will be needed to prevent the capital regulation ineffectively.