There’s been a lot of criticism of David Cameron recently but this extract of a speech that he gave more than six months ago showed a pretty good understanding of the issues of capital inadequacy and illiquidity at the heart of this crisis:

“As well as the reforms we have outlined for the UK financial
system, we need reforms at a global level too. So let me suggest one
important reform that needs to take place in light of the recent crisis
in world banking.

“The Basel capital accords determine how much
capital a bank must set aside for a given amount of lending. This makes
good sense, and, for obvious reasons, it is right to set the rules at a
global level. But economists have identified some key problems with the
current Basel accord.

“First, the rules on liquidity, which has
been at the core of the current crisis, are too weak. Banks can operate
with enough funding only to survive for a couple of weeks, but still be
within the rules. Second, we need to examine which asset classes and
which institutions are covered by existing rules. For example, the
zero-weighting of some triple A assets has led to distortions in asset
allocation. Put simply, some of the debts were kept off balance sheet
so they didn’t count as lending under the rules.

judgements about credit risk were delegated to rating agencies who
themselves had incentives to expand the amount of lending that was
allowed under the rules. Put simply, because they are paid fees for
rating debts, credit rating agencies had an interest in there being as
much debt as possible. Finally, market risk was measured by backward
looking models which tend to exacerbate the credit cycle, not dampen
it. When credit is easy, the models allow more lending. When credit
tightens, the models reduce the amount of permitted lending.

short, liquidity risk was all but ignored, credit risk was delegated,
and market risk was backward looking. And we now know that not only did
the regulators not know, but too often the banks themselves didn’t
know, the full extent of the risks they were subjected to. But let me
say again, any reforms at an international level will need care to
ensure that in tackling the past problems they do not create the
problems of the future. At the same time, we must all recognise that
crises are inevitable, so a prudent Government, as we will be, that is
committed tol be, must improve our response to these crises when they

Thanks to Richard North of EU Referendum blogspot for pointing the extract out to us.

16 comments for: © David Cameron, 28th March 2008

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