
How regulatory reform shapes the financial cycle
Ambitious regulatory reform has changed the dynamics of the global financial system. Capital ratios of banks have increased significantly, reining in bank credit. Counter-cyclical bank capital rules slow credit expansions by design and yield greater influence to non-banks. Meanwhile, the liquidity coverage ratio has restricted one of the key functions of banks: liquidity transformation. Regulation has also created its own moral hazards. In particular, the preferential treatment of government bonds has boosted their share in bank assets. The neglect of sovereign risk in liquidity regulation constitutes a significant systemic risk as public debt-to-GDP ratios are at or near record highs in many key economies.