Basel 2.5

• The financial crisis that began in the summer of 2007 revealed limitations and gaps in the  existing solvency and liquidity regulations. Market prices of financial assets fell sharply during  2007-2009. In addition, many assets not already illiquid became so, the soundness of  securitizations was doubted, and many hedging strategies failed. It was clear that minimum  capital charges under the market risk amendment were inadequate for the trading-book risks  revealed during the crisis.

• The Basel Committee responded with updated rules for capital for the trading book, making  three major changes:

1.VaR calculations were expanded to include a stressed-VaR component;

2.Capital for incremental risk was added (roughly capturing the jump-to-default risk);

3.Comprehensive  risk  capital  requirements  were  added  for  securitizations  and  related  instruments.

These changes were implemented by the end of 2011.

• Earlier, most banks computed capital under the market risk amendment using historical  simulation, (i.e., 1-day VaR was computed by drawing daily changes in value from recent history and then converted to VaR by multiplying by
• such a practice causes measured VaR to gradually decline because all or nearly all of  the  historical observations have small changes in value. When volatility rises again, as it did in 2007  for many assets, VaR from historical simulation was slow to follow because most historical  observations were from a low volatility period.

Basel 2.5-Stressed VaR

• The Basel Committee introduced a requirement for use of  stressed-VaR measures to counter  such tendencies. A bank is required to identify the one-year (i.e., 250 day) period from the most  recent seven years that was most stressful for its current portfolio. Because this will be the sub-  period with the highest fraction of portfolio-weighted large declines in value, the resulting 1-day  VaR will be relatively large and will not change much as time passes (unless a period of low  volatility persists for 7 years).

Stressed VaR was combined with the traditional VaR measure in an expanded formula

𝑀𝑅_2.5 = 𝑚𝑎𝑥(𝑉𝑎𝑅_t–1, 𝑚_r × 𝑉𝑎𝑅_avg)  + 𝑚𝑎𝑥(𝑆𝑉𝑎𝑅 _t–1 , 𝑚_s × 𝑆𝑉𝑎𝑅_avg)

where

𝑉𝑎𝑅_t–1 is the previous day traditional 10-day, 99 percent 𝑉𝑎𝑅,

𝑉𝑎𝑅_avg is the average of the 𝑉𝑎𝑅𝑠 of the 60 most recent days,

𝑆𝑉𝑎𝑅_t–1 is the previous day stressed 10-day 99 percent 𝑉𝑎𝑅 which is calculated by drawing  observations from the equivalent times during the most stressful period in the past seven years.

𝑆𝑉𝑎𝑅_avg is the average of the stressed 𝑉𝑎𝑅𝑠 over the last 60 days.  multipliers 𝑚_r and 𝑚_s must be at least 3 as under the 1996 Amendment.

• Because the definition of the stress period is such that the most recent period cannot be more  stressed than the stressed period, and the charges based on traditional and stressed VaR are  summed, 𝑀𝑅_2.5 must be at least twice as large as MR calculated under the 1996 Amendment as  long as the multipliers are equal.

Basel 2.5-Incremental Risk Charge

• The incremental risk charge (IRC) combines two strands of work, which were released as

i.a reaction to regulatory arbitrage opportunities between the banking and trading book, and

ii.a reaction to the crisis.

• Banks had learned by the early 2000s that even with the specific risk charge, most banking-book  exposures had smaller capital requirements in the trading book than in the banking book. A  one-year 99.9% confidence level VaR was required for calculating capital for the banking book  while a multiplier was applied to a 10-day 99% VaR for capital to back the trading book. Thus,  many illiquid instruments posing default risk were placed in the trading book.

• To remove this incentive, the Basel Committee proposed adding an incremental default risk  charge (IDRC). Two variants were proposed:

1. An internal model of  default risk calibrated to the same 99.9th percentile at a one-year  horizon as the Committee’s IRB approach

2. Or, in the  absence of  such a model, either a “standardized“ or a “current exposure”  approach that had some similarity to Basel I capital charges for specific risk.

As a practical matter, capital in the trading book would be the greater of market risk capital and banking book capital.

• Late in the crisis, however, the Committee had realized that most losses in portfolio value  associated with credit risk had been due to changes in ratings, credit spreads, or liquidity, not  defaults. As a result, the scope of the proposal was increased to include changes in ratings.

1. The same 99.9th percentile was used, but in addition to defaults, banks were required to  estimate losses associated with rating downgrades.

2. Portfolio credit quality is held approximately constant by an assumption that any position  that is downgraded or that defaults is replaced by a position with the same pre-downgrade  rating. A loss is recorded from sale of the downgraded or defaulted position.

3. The period over which replacement could occur differs across positions according to their  liquidity but is never less than three months.

Basel2.5-Correlations and the Comprehensive Risk Measure

• An assumption embedded in Basel II is that the correlation parameter in the Gordy (2003)  model is constant across obligors and over time (though not across types of assets). This  assumption is not reasonable for for instruments in the correlation book (e.g., securitizations,  re-securitizations and derivatives written on securitizations). In reality, correlations change over  time and such changes can have large effects on the value of tranches For example, the market  prices of AAA-rated tranches were consistent with a near-zero probability of default pre-crisis,  but during the crisis market estimates of PD increased significantly and tranche prices fell.

• The Basel Committee addressed this issue by replacing the IRC and specific risk charge with a  comprehensive risk (CR) charge for the correlation book. Under the new rules, banks may use a  standardized approach (summarized in the following table) that depends only on the rating of  the instrument. (Note that percentages are capital as a fraction of the exposure, not risk weights.

 

	AAA, AA	A	BBB	BB	<BB, unrated
Securitizations	1.6%	4%	8%	28%	100%
Re-securitizations	3.2%	8%	18%	52%	100%

 

• Because re-securitizations (for which the underlying pool of assets are the tranched liabilities of  securitization vehicles) are more vulnerable to changes in correlations, capital requirements are  much higher for them. Meanwhile, tranches rated below BB are the most exposed to losses in  the underlying pool (i.e., in effect they must be financed entirely with capital).

• Banks may also use an internal model to estimate the CR charge if approved to do so by  supervisors, though the model based charge may not be less than a fraction of the charge under  the standardized approach. The internal models must be complete and robust. The following  must be modeled ideally with simulations that revalue the whole portfolio for each iteration of a  simulation –

1. Multiple default and rating change events

2. Volatility in correlations and credit spreads; basis risk (e.g., the difference between CDS and  underlying index values)

3. The dynamics of hedges Volatility in recovery rates

Need For Basel 3

• In addition to the need for more capital for risks in the trading book, the crisis revealed many  other weaknesses of the Basel II framework:

1. In the depths of the crisis, market participants cared only about tangible Tier 1 common  equity capital. Many elements of the pre-crisis definition of capital proved limited in their  ability to maintain banks as going concerns.

2. The official sector came to believe that distress at some banks posed greater threats to  society than distress at other banks. Categories of “systemically important” financial firms  were created and embedded in a wide range of regulatory and supervisory practices.

3. Risk-based capital ratios were too susceptible to manipulation. Leverage-ratio capital  requirements were needed as a backstop, especially since market participants who focused  only on tangible common equity tended to also focus only on leverage ratios.

4. It was not enough for banks to remain solvent up to the point of  maximum losses – they  also had to be able to operate as a going concern thereafter, which meant they needed  substantial capital after absorbing the losses. In many cases, governments provided capital,  but such provision was unpopular. Buffers of capital above the minimum requirements were  needed along with means of recapitalizing failed banks.

5. Entities that were thought to be solvent by regulators suffered runs and, in some cases, failed. This was in part because their liquid reserves proved inadequate to cover withdrawn  funding and in part because wholesale funding proved to be unstable. Thus, liquidity  requirements were needed.

6. It became clear, especially after the failure of Lehman that capital was needed to cover  counterparty credit risk, as Lehman did not honor its commitments as a counterparty in  derivative contracts.

Proposals to remedy the deficiencies were published in 2010 and 2011 and amended later.

• In addition, a Large Exposures Framework was created in 2014 to set a common global  standard to limit exposure concentrations to a single counterparty, particularly between  systemically important institutions. Specifically, the limits are 25% of capital (and 15% between  global systemically important banks). This framework assumes 100% probability of default and  100% loss given default (after netting and collateral adjustments), limited use of  models that  failed in the crisis, and aggregates across wholesale credit, trading and other books. LEF also  addresses a limitation of the capital framework, which does not adjust capital requirements for  significant concentrations under either the Standardized Approach or the Gordy Model used in IRB (which assumes exposures are granular, not concentrated).

Basel 3-The Definition of Capital

• Basel III eliminated Tier 3 Capital and divided Tier 1 Capital into Tier 1 Equity Capital (also  known as Core Tier 1 Capital) and Additional Tier 1 Capital, restricting the former to high-  quality capital.

• Minimum capital requirements were also changed: Core Tier 1 must be at least 4.5 percent of  risk-weighted assets, and Total Tier 1 (i.e., the sum of  Core and Additional Tier 1) capital must  be at least 6 percent of  risk-weighted assets. The Total Capital requirement (Tier 1 plus Tier 2)  was left unchanged at 8 percent.

• Tier 1 Equity Capital includes

1. common equity,

2. retained earnings, and

3. a limited amount of minority interest and unrealized gains and losses.

Goodwill and other intangibles are deducted, as are deferred tax assets and any shortfall of  reserves relative to IRB expected losses.

Additional Tier 1 Capital includes:

4. Unsecured, unguaranteed, non-cumulative perpetual preferred equity instruments

5. subordinated to depositors and subordinated debt, and callable only after five years or more.

6. Debt with appropriate triggers that cause conversion to equity or write-downs.

7. Approved minority interest not included in Core Tier 1.

• Tier 2 capital is designed to absorb losses after failure. It includes:

1. Subordinated debt. Specifically, unsecured, unguaranteed, debt instruments subordinated to  depositors and subordinated debt, with five years or more original maturity, and callable  only after five years or more.

2. General loan loss reserves. These are reserves not allocated to absorb losses on specific  positions. Reserves included in capital are capped at 1.25% of standardized approach RWAs,  or 0.6% of IRB RWAs.

A number of other deductions are required, such as

1. defined-benefit pension plan deficits,

2. certain cross-holdings within a group, and

3. mortgage servicing rights greater than 10 percent of common equity.

• Overall, capital requirements were significantly increased relative to Basel 2.

Basel 3-Leverage Ratio Capital Requirement

• Prior to Basel 3, minimum capital ratios specified by the Basel Committee were expressed as a  percentage of risk-weighted assets (RWA). However, during and after the crisis many observers  felt that RWA had understated the risks borne by banking organizations and thus led them to be  over-leveraged. Though known weaknesses in the calculation of RWA were addressed, the  possibility of future mismeasurement remained.

• The Committee’s reaction was to introduce a “simple” leverage ratio capital requirement as a  supplement to the risk-based requirements: banking organizations must maintain a ratio of  Core Tier 1 Capital to Leverage Exposure of 3 percent or more.

• Leverage Exposure includes both on-balance-sheet assets and fractions of off-balance-sheet  assets (e.g., derivatives or potential futures exposures). Though the IFRS and GAAP accounting  standards differ somewhat in their handling of off-balance sheet assets, the  Committee’s  Leverage Exposure measure is specified in some detail to promote comparability across nations.

Basel 3-Systemically Important Financial Institutions

• The FSB publishes lists of globally systemically important banks (G-SIBs) and (in cooperation  with the IAIS) globally systemically important insurers (G-SII). Some nations also designate  other banks as domestically systemically important (D-SIBs). Collectively, these and other firms  fall into the category of systemically important financial institutions (SIFIs). To determine  whether an entity is a G-SIB, the FSB combines variables that  proxy for  size,  interconnectedness, complexity, international activity and other matters. An entity is systemically  important if its failure or distress would cause substantial problems in the financial system or  the real economy. For example, the aftermath of Lehman’s failure demonstrated that it was  systemically important because many financial markets were disrupted, and many counterparties  suffered because Lehman failed to satisfy its obligations.

• SIFIs are often presumed to be “too big to fail”, but key goals of reforms include reducing the  likelihood of failure while also making it possible for any entity to “fail” without disrupting the  financial system or the real economy. The goal is for the entity to keep operating and be  recapitalized without government assistance. systemically important firms are often subjected to more wide-ranging supervision and regulation.

Basel 3-Buffers

• As of early 2019, the Basel specifications feature three requirements for capital above the  minimum fractions of RWA:

1.A 2.5 percent capital conservation buffer (CCB) requirement.

2.An additional G-SIB requirement that depends on an organization’s score when the  Committee applies its method to identify G-SIBs. These additions are 1, 1.5, 2, 2.5 and 3.5  percent.

3.A Countercyclical Capital Buffer (CCyB) that varies at the  discretion of  national  supervisors and is between 0 and 2.5 percent.

• The rationales for the buffers differ somewhat.

1. In the case of the CCB, the rationale roughly follows that for the Prompt Corrective  Action (PCA) system built into U.S. capital regulation beginning in 1991 (i.e., a bank with  ratios that begin to approach the minimums should be subject to increasingly stringent  supervisory intervention in order to induce a return to well-capitalized status).

2. In the case of the G-SIB buffer, the rationale is similar to that for the CCB but also  recognizes the very large costs to society of distress at G-SIBs (and the higher volatility of losses at some of them). Thus, larger buffers are specified to further reduce the chance of  failure. A breach of  the G-SIB buffer has consequences similar to a breach of  the CCB.

3. The CCyB has two rationales. One is to provide an instrument for macroprudential restraint  of overheating; the other is attentive to the cost of capital.

a)The overheating rationale proposes that higher bank capital requirements tend  to  restrict credit supply by banks, and thus prevent overheating in the credit markets,  thereby reducing the amplitude of the credit cycle and perhaps reducing the frequency  and severity of financial crises. A consequence of the overheating rationale is that  computation of the CCyB requirement is complicated for banks with international  operations.

b)The cost-of-capital rationale presumes that a bank’s costs of increasing its capital ratio  are smaller in good times than in bad times, which implies that increased financial  stability can be obtained at lower cost by increasing the CCyB during good times and  reducing it during bad times. Implicitly, this rationale focuses on capital market costs  for the entity as a whole, without regard to conditions in different nations’ credit  markets. As a practical matter, different supervisors give different weights to the two rationales.

• The consequences of violating the CCyB are similar to those of violating the CCB. However,  because national supervisors can reduce the CCyB at any time, such consequences can be  mitigated by changing the requirement.

• All of the aforementioned requirements apply only to risk-based capital ratios.

• In 2017, the Committee introduced a leverage ratio buffer for G-SIBs as well, equal to one-half  of its risk-based G-SIB buffer (not including the CCB or CCyB).

• Earlier, the U.S. had implemented a 2 percentage point leverage buffer requirement for G-SIB  consolidated organizations, and a 3 percentage point buffer for subsidiary banks, for  an  aggregate minimum of 5 and 6 percent, respectively.

• In 2018, the U.S. proposed to change its G-SIB leverage buffer to half of the sum of CCB and  G-SIB risk-based buffer requirements.

Basel 3-Liquidity Requirements

• During the crisis, perhaps the most notable example of a failure involving a run was that of  Northern Rock. Heavily dependent on securitization markets to fund its mortgage business, the  bank had trouble finding enough wholesale funding to finance its pipeline of mortgage loans  when securitization became difficult.

• The trouble began when news broke on September 13 (a Thursday) that the Bank of England  would provide liquidity support. In the response to the prospect of government intervention, a  substantial fraction of retail deposits was withdrawn and Northern Rock’s wholesale funding  fell. With most of its remaining assets illiquid, Northern Rock found itself in imminent danger  of being unable to meet further requests for withdrawals. By the following Monday, the  government announced that all deposits would be guaranteed for all U.K. banks.

• These types of events made it clear that but liquidity risk can cause bank failures as well. Hence,  an important objective of Basel III was to enhance liquidity risk management in financial  institutions. Basel 3 addressed liquidity risk by specifying two requirements, the  liquidity  coverage ratio (LCR) and the net stable funding ratio (NSFR).

• The LCR is designed to give banks and authorities a month to manage a crisis by selling liquid  assets. The idea is that if the bank has more liquid assets than it needs to meet liquidity  demands during the month, it can sell the assets while attempting to restore confidence in itself.  To be “liquid”, there should be a high probability that the asset can be sold quickly and with  little reduction in price. The requirement is defined as

• The quantity of a bank’s high-quality liquid assets (HQLA) is measured by placing assets in  categories and applying haircuts according to the likely availability of buyers at prices near  normal-times values. For example, deposits at central banks and securities issued by central  governments are included in HQLA without a haircut. In contrast, corporate debt and equity  have 50 percent haircuts and individual mortgage loans are excluded from HQLA entirely.

• Net cash outflows are computed by applying assumptions about the tendency of  different  classes of liabilities to be withdrawn in stress situations, and the tendency credit line holders to draw on them. For example, only 3 percent of insured retail deposits are assumed to be withdrawn, whereas that number is 100 percent for most non-operational wholesale deposits  and 30 percent for undrawn capacity of lines of credit to nonfinancial wholesale customers.
• The NSFR uses a one-year period and is conceptually slightly different, in that it focuses not on  what can be sold but rather what funding would remain after a stressful year. It is defined as

• The available amount of stable funding is calculated by multiplying the amount in several  categories of funding by available stable funding (ASF) factors (which are similar to haircuts).  However, these categories are different from those of the LCR. The required stable funding is  similarly calculated by multiplying amounts in each category of asset by required stable funding  (RSF) factors, where the factor is higher the more illiquid the asset (since it cannot be sold as  easily when funding runs off).

• One lesson of Northern Rock is that provision of funding by central banks can make funding stresses worse, not better, and doing so for one bank can destabilize a banking system.  Thus, banks must be much better prepared to survive periods of funding stress with their own  resources. This means that balance sheet composition is somewhat constrained, with a smaller  proportion of illiquid assets and a larger proportion of illiquid liabilities.

EXAMPLE – LCR and NSFR

• A bank’s liabilities consist of USD 500 of stable retail deposits with 9 months or less remaining  maturity, USD 200 of 3-month wholesale certificates of deposit with one-third maturing each  month, USD 200 of 10-year senior bonds with none maturing in the next year, and USD 100 of  common equity. ASF factors for these categories of liability are 95%, 0%, 100%, and 100%,  respectively.

The bank’s assets consist of USD 100 of  vault cash, USD 100 of  the debt of  its sovereign,  USD 100 of corporate debt securities rated BBB in the trading account, and USD 700 of loans  to businesses with more than one year of remaining maturity and risk weights of 50% or more. The RSF factors for these assets are 0%, 5%, 50%, and 85%, respectively.

Basel 3

For the LCR, HQLA factors (1-haircut) are 100%, 100%, 50%, 0%, presuming the supervisory  allows inclusion of the corporate debt securities. Note that the corporate debt securities are  Level 2 assets, which may not comprise more than 40% of HQLA after the haircut. This is  satisfied since total HQLA is USD 250, of which USD 50 is the corporate debt securities.

Assume a 5% runoff rate for the stable retail deposits, a 100% runoff rate for the one-third of  wholesale CDs that mature in the next month, and a 0% runoff  rate for senior bonds and  equity, so

Thus, the bank in this example would be in compliance with the LCR and NFSR. Note that a  very large number of categories, factors and haircuts were not discussed in this example and the liquidity requirements are operationally complex.

Contingent Convertible Bonds-CoCos

• Traditionally, convertible bonds were issued by non-financial firms who wished to avoid the  dilution of issuing equity before the firm’s performance improved. Such bonds would, at the  option of the holder, convert into equity when the firm’s share price exceeded thresholds  specified in the indenture. For banks, contingent convertible bonds (CoCos) are the mirror  image: they cause a bank’s equity to increase when distress occurs, as reflected by triggers  written into the indenture, and not at the option of the holder. With CoCos, equity increases  either because the bond converts to equity or because its value is written down.

• A common trigger is when ratio of  Core Tier 1 Capital to RWA falls below a threshold, or when  a bank’s primary regulator declares it to be nonviable. CoCos may be included in Additional Tier  1 Capital if the threshold is 5.125 percent or higher, and Tier 2 capital otherwise.

• Since CoCos are debt instruments when issued, holders receive little or none of the high returns  received by equity holders when a bank does well, but holders bear losses not so different from  those of equity holders when a bank fails. Thus, they should be expensive for a bank to issue.  But they do have an accounting advantage: because they do not appear in the equity account  until converted,  bank can report a higher return on equity.

Other Local Applications of Basel and Stress Testing

• While Basel I, II and III have achieved some level of harmonization across countries, significant  differences persist. Little effort has been made to fully adjust for differences in accounting  standards, bankruptcy laws, or other rules or regulations with differences across countries. Even  where there is agreement in Basel, some jurisdictions apply tighter treatments than others. For  example, many European countries treat all banks as internationally active and subject to Basel  rules, while the U.S. considers only its largest banks as internationally active, with less stringent  requirements applied to many regional and community banks that only operate in one or a few  states with little international activity.

• Gold plating regulations means setting the domestic standards higher than  minimum  international standards. Though participating countries are not supposed to  promulgate  domestic laws and regulations that are less onerous for internationally active banks, they may  enact requirements that are super equivalent (i.e., imposing a different but higher, or just a  higher standard than Basel requires). This approach sometimes acts as a safety valve in the Basel  negotiations, allowing those who want stronger standards for everyone to at least have them  domestically, and sometimes it reflects a nation’s special circumstances. Switzerland’s choices are in the latter category: as a small country with two huge G-SIBs, it found itself during the crisis in the uncomfortable situation of being unable to recapitalize its G-SIBs  should that have been necessary. Thus, its capital requirements are more onerous than those of  Basel 3, and in resolution planning it has required the G-SIBs to structure themselves so that  domestic operations could continue even if international operations failed. The  United  Kingdom has taken a somewhat similar step, requiring that retail operations be ringfenced (i.e.,  separated from) wholesale operations.
• Basel anticipates that in addition to minimum standards, each jurisdiction will supervise banks  and take other actions to ensure they have adequate capital and liquidity, and strong risk  management and governance. In the U.S., coordinated stress tests based upon supervisory  designs and scenarios ensure that banks have capital and liquidity planning processes, risk  management, and sufficient buffers to allow compliance with minimum capital and liquidity  standards even in a stressed situation.
• The Federal Reserve’s Comprehensive Capital Analysis and Review (CCAR), which requires  participation by G-SIBs and D-SIBs with material operations in the United States, includes a supervisory severe scenario that has been one of the more severe stress tests. For some banks, CCAR stress testing is the binding capital constraint, as restrictions on  dividend  payments and share buybacks apply if the bank’s capital ratios fall below the requirement  minimums after losses in the “severely adverse” scenario are included. This approach requires  banks to hold buffers that should allow them to meet their minimum capital requirements even  in stressed scenarios and is consistent with past expectations that banks should have a cushion  above Basel minimum capital requirements. Furthermore, that cushion is likely greater than in  the past.
• Similarly, there is a program for liquidity known as CLAR that assesses bank stress testing and  supervisory provided stress tests to ensure liquidity buffers are maintained. In 2019, elements of  CCAR have been relaxed to reduce in future periods the use of qualitative criteria (relating to  bank risk management and capital planning processes) in judging results.

Other Reforms

• A vast array of legislation and regulations was implemented across the globe in the decade after  2007. These include:

1. Capacity to conduct macroprudential policy was added through institutional reforms in  some nations where legal authority was previously lacking. For example, in the US, bank  regulators’ missions often restricted them to consider only the soundness of  individual  banks, not the financial system as a whole. The Financial Stability Oversight Council  (FSOC) was created to take a more macroprudential view, though its legal authority was  somewhat limited. In the United Kingdom, the Financial Policy Committee was created at  the Bank of England, with some power to take macroprudential policy actions and to  recommend others to Parliament.

2. Pre-crisis compensation practices at large banks that made pay effectively independent of  risk-taking were widely blamed for imprudent risk taking. The FSB promulgated principles  for better compensation practices, and many nations responded with increased supervision  and regulation. Some elected to take a more formal approach, in some cases restricting the  level of pay, while other nations focused on supervision of the presence of risk-sensitive  features in compensation arrangements.

3. In the US, the Volcker Rule (part of the Dodd Frank Act) restricts proprietary trading and investments in hedge funds and private equity at deposit-taking financial firms. The  rationale is that banks should not be permitted to “speculate” while being funded by  insured depositors. However, the Volcker Rule has proved difficult to enforce because of  challenges in identifying the intent of a trade and in separating hedging activity from  speculative activity. Nevertheless, most banks shut down their proprietary trading desks.

4. In the US and in the European Union, some over the counter derivatives (i.e., those that  are relatively standard n form and terms) must be traded on swap execution facilities  (SEFs), which are electronic platforms that promote price transparency. Derivatives traded  between financial institutions must be cleared by central counterparties (CCPs).

5. In the US, an Office of Credit Ratings was created at the Securities and Exchange  Commission to provide oversight of rating agencies, though its powers were somewhat  limited. Prior to the crisis, rating agencies had been subject to relatively little regulatory  oversight and they were widely blamed for underestimates of the credit risks posed by  securitizations.

6. In the  US, a Consumer Financial  Protection Bureau (CFPB) was created  to improve  information flows to consumers of financial products and to curb abuses by financial  firms of all kinds.

7. In the US, mortgage lenders were required to determine whether borrowers have the ability  to repay the loans they take. The legal and financial liabilities associated with mistakes in  such determinations have caused many banks to exit the mortgage market.

8. In the US, large banks were required to have board risk committees where at least one  member has risk management experience at a large financial firm.

9. In the US and the European Union, issuers of  securitizations were required to retain at least  5 percent of each tranche, in an attempt to better-align the incentives of  issuers and  investors.