Basel III and the Regulation of Market-Based Finance: The Tentative Reform

Abstract

Since the mid-2010s, with memories of the global financial crisis of 2008 (GFC) progressively fading, there has been increasing recognition of the potential contributions of market-based finance. This refers to credit intermediation conducted by non-bank entities, effectively what was termed in 2007 shadow banking. A number of policy-makers in the post-crisis years have praised the opportunity to reconcile shadow banking with resilient market-based channels of intermediation. The G30 in 2016 stressed particularly the potential that lies in securitisation and other forms of market-based finance. In the process though, market-based finance is also proposing the re-emergence of a business model that in the pre-crisis years was known as securitised banking.The post-crisis narrative suggests that the regulatory corrections that have been implemented since 2008 should contribute to transforming shadow banking into resilient market-based finance. The Basel III framework sits at the heart of the post-crisis regulatory architecture, and it was designed to protect large financial institutions from the risks flowing from market-based channels of intermediation. This general optimism though clashed with the economic slowdown caused by the COVID-19 pandemic in the spring of 2020, particularly insofar as it exposed some deep-seated fragilities in the financial system.This article therefore engages with a critical appraisal of that regulatory edifice, analysing in particular its capacity to respond to risks associated with pre-2008 securitised banking, as well as the challenges emerging from the more recent morphing in market-based channels of intermediation. The new Basel framework appears to provide the necessary safeguards to guarantee the stable operations of restored capital markets. This article observes though that despite providing much needed regulatory improvements from the pre-crisis regime, the current framework is still falling short in protecting the financial system from the risks that are generated by the evolution of market-based finance.