Systemically Important Banks and Capital Regulation Challenges

Bank regulation might have contributed to or even reinforced adverse systemic shocks thatmaterialised during the financial crisis. Capital regulation based on risk-weighted assets encouragesinnovation designed to circumvent regulatory requirements and shifts banks’ focus away from their coreeconomic functions. Tighter capital requirements based on risk-weighted assets may further contribute tothese skewed incentives. The estimated macroeconomic costs of redirecting banks’ attention away fromsuch unconventional business practices are low. During a medium-term adjustment period, for eachpercentage point of bank equity, regulation that is not based on risk-weighted assets would affect annualGDP growth by -0.02 percentage point more than under the risk-weighted assets framework. Refocusingbanks’ attention toward their main economic functions is a core requirement for durable financial stabilityand sustainable economic growth.