then reporting, such a thing as incentives.
They may be sort of here and there.
But overall this is about like this.
Now it's the time to draw a line and start talking about Basel process.
Now Basel process was started in Switzerland,
in Basel Switzerland in nineteen eighty eight by the introduction of
the so called Basel one requirements,
that happened in 1988.
So they primarily dealt with
solvency and they introduced some ideas like,
the risk weighted average.
So if we go back for a moment for this,
balance sheet, they basically ascribe some coefficients of the risk to these assets.
And if let's say, you hold a lot of derivatives that are very risky,
then the average market estimate of your assets will be much lower.
So if it is lower,
then you are forced to raise your capital or otherwise you risk insolvency.
Then also here, closely to that are capital requirements and also this,
that is about the same if you have,
this is leverage requirements.
So basically all that dealt with the idea that,
we have to prevent situations when a bank might find,
or a bank like institution that is covered by this kind of regulation.
That it does not find itself in the situation when
the market value of its assets falls short of the market value of liabilities.
Now, that
The time would go by, and then,
there was the development of that in Basel II 2004.
Well, you can say that nothing really bad happened in between 88 and 2004.
Well, with the exception of the dot com crisis there can hardly be closer link to this.
But then, the main emphasis has shifted a little bit because that time,
witnessed the introduction of a lot of new and very risky financial instruments.
So the major emphasis here was risk.
You can say, well, this is not exactly the solvency as liquidity.
Well, it is both to an extent.
So, what they did there were
refined capital requirements because
just straightforward capital requirements happened to be not very efficient.
Then, risk management systems,
because it happened to
be a problem to properly address the risk of these assets.
The question was, who measures this risk?
Because for example, if the institution does that using its proprietary measures,
proprietary models, then clearly,
they have an incentive to first of all,
not to do that transparently,
and second of all, to sort of support their own interests.
Then, also, there were some other things here.
But the general idea was to be sure that we deal with this risk properly.
And then finally, there is Basel III,
that is 2010 and 11 and on,
because this is a developing process.
And here, there was a lot of other things addressed.
First of all, again, at the first glance,
it seems to be close like capital adequacy.
Well, we said we already have that.
But like I said,
it's always like when you
introduce new financial instruments and they have to react properly.
Then, again, it was leverage revisited.
And the main emphasis was on liquidity here.
So, in our dichotomy,
we can say that this is liquidity.
And I would put in the red two huge issues that were introduced for the first time,
because that was after the acute phase of the global financial crisis.
This is stress tests.
So, the banks should pass these stress tests.
So, what if the economy takes a negative path?
What would happen with the assets,
the levels of this of this bank?
And would it still be able to
stay within these requirements for both solvency and liquidity?
And finally here, so,
I would put a big exclamation mark here.
And then, the laws, the issue of too big to fail was addressed here.
Well, we study this issue in much greater detail in our fifth week,
and some in the sixth week too.
So here, I would just say that,
it was for the first time recognized.
Now, what else can be said about this Basel process?
Well, I would say that clearly,
with this whole process is the reaction to
new high risk instruments
because I mentioned before that regulator was always behind,
and the financial institutions always ahead.
That means that, you introduced some regulation.
And then, the banks find a way,
so as to stay within these regulations but
still expose the investors to significant risks.
Now, the issue of too big to fail, like I said,
just was another challenge because basically,
this is blackmail on the side of the bank.
And they say, well,
we keep doing these things,
and if you don't help us,
if you don't save us if bad things happen, then,
you cannot afford it because we will bury under ourselves big segments of the market.
So here, I would also mention the criticism of this process.
Well, as always, some people say that restrictions are bad. We talked about that.
