The Role of Basel II in the Subprime Financial Crisis: Guilty or Not Guilty?

Abstract

Since mid-2007, an increasing number of people among economists, policy-makers and market operators have blamed the Basel II framework for banks' capital adequacy to be a major cause for the subprime financial crisis. While several issues related to the functioning of financial markets have been examined, the new prudential regime for banks might appear as the main suspect to be blamed. However, some simple questions arise. Can we just ascribe the financial crisis to Basel II? Should regulators discard the whole Framework or, rather, try to overcome its limits but preserving the backbone of the new discipline? The objective of this paper is to provide some answers to these questions. After a short review of the main features of the financial crisis as well as of the rationale behind the Basel II rules, we try to describe the actual role played by the new prudential regulation in the crisis and discuss the main arguments raised in the current debate, discriminating between more constructive criticisms and weaker accusations. We conclude that, while it is urgent to strengthen those aspects of Basel II that have not worked properly during the crisis, there are not sound reasons for abandoning the philosophy underlying the new Framework.