A perspective on the symptoms and causes of the financial crisis |
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Authors: | Ricardo Cabral |
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Institution: | University of Madeira, Department of Management and Economics, 9020-105 Funchal, Portugal; Centro de Estudos de Economia Aplicada do Atlântico (CEEAplA), 9501-801 Ponta Delgada, Portugal |
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Abstract: | Prior to the 2007–2008 financial crisis, banking sector profits were very high but the profitability of financial intermediation was poor. Using a novel model of banking, this article argues that the high profits were achieved through balance sheet expansion and growing default, liquidity, and term risk mismatches between assets and liabilities. As a result, large banks’ financial leverage rose as they became less liquid, setting the conditions for a systemic banking crisis. This article argues that the increase in financial leverage was possible due to misguided changes in the regulatory framework, specifically, the Basel I capital accord and reductions in reserve requirements. Finally, this article overviews and assesses the policy response in the aftermath of the crisis. |
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Keywords: | E51 G01 G21 G28 |
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