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Restoring Confidence In The Financial System: See-through leverage: a powerful new tool for revealing and managing risk by Sean Tully, Richard Bassett

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4: How The Current System Failed And The Need For See-Through Leverage (STL)

Chapter summary
  • The drive of banks to optimise short-term return on capital (ROC) for equity investors motivated the creation of the shadow banking system.
  • Basel II addressed some of the flaws of Basel I by making capital requirements more sensitive to expected losses, while increasing risk due to leverage.
  • New structures of the shadow banking system in combination with Basel regulations allowed a massive drop in required capital for the same level of risk.
  • The combination of ratings, regulations and financial engineering facilitated a massive increase in leverage.
  • A new language of risk – see-through leverage or the family of STL risk indices – is introduced, ...

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