Caprio, Gerard, Jr.Demirgüç-Kunt, AslıKane, Edward J.2012-05-222012-05-222008-10https://hdl.handle.net/10986/6309The intensity of recent turbulence in financial markets has surprised nearly everyone. This paper searches out the root causes of the crisis, distinguishing them from scapegoating explanations that have been used in policy circles to divert attention from the underlying breakdown of incentives. Incentive conflicts explain how securitization went wrong, why credit ratings proved so inaccurate, and why it is superficial to blame the crisis on mark-to-market accounting, an unexpected loss of liquidity, or trends in globalization and deregulation in financial markets. The analysis finds disturbing implications of the crisis for Basel II and its implementation. The paper argues that the principal source of financial instability lies in contradictory political and bureaucratic incentives that undermine the effectiveness of financial regulation and supervision in every country in the world. The paper concludes by identifying reforms that would improve incentives by increasing transparency and accountability in government and industry alike.CC BY 3.0 IGOACCOUNTABILITYACCOUNTING PRINCIPLESAFFILIATESAMOUNT OF CAPITALARBITRAGEASSET HOLDINGSASSET POOLASSET PRICESASSET QUALITYASSET SALESASSET VALUESASYMMETRIC INFORMATIONAUDITINGBAILOUTSBALANCE SHEETBALANCE SHEETSBANK LOANSBANK REGULATIONBANK REGULATIONSBANKING CRISESBANKING CRISISBANKING INDUSTRYBANKING SYSTEMBARRIERS TO ENTRYBIDBOND ISSUEBOND ISSUESBONDSBOOK VALUEBORROWERBUSINESS CYCLECAPITAL ADEQUACYCAPITAL REGULATIONCAPITAL REQUIREMENTSCAPITAL SHORTAGECASH FLOWSCDSCENTRAL BANKCENTRAL BANKSCOLLATERALCOMMERCIAL BANKSCOMMERCIAL PAPERCONFLICT OF INTERESTCONFLICTS OF INTERESTCORPORATE BONDSCORPORATE DEFAULTCORPORATE GOVERNANCECORPORATE STOCKCREDIBILITYCREDIT DEFAULTCREDIT DEFAULT SWAPSCREDIT ENHANCEMENTSCREDIT LINESCREDIT QUALITYCREDIT RATINGCREDIT RATINGSCREDIT RISKCREDIT RISKSCREDIT SPREADCREDIT SPREADSCREDIT STANDINGCREDIT SYSTEMSCREDITORSCREDITWORTHINESSDEBTDEBT CRISISDEBT OBLIGATIONDEBTSDEFAULT PROBABILITIESDEFAULT RATEDEFAULT RATESDEFAULTSDEPOSITDEPOSIT INSURANCEDEPOSIT INTERESTDEPOSITORSDEPOSITORY INSTITUTIONDEPOSITSDERIVATIVEDERIVATIVE INSTRUMENTSDERIVATIVESDEVELOPING COUNTRIESDISBURSEMENTDUE DILIGENCEEARNING POWERENFORCEMENT SYSTEMSEQUITY CAPITALEQUITY VALUEEXCHANGE COMMISSIONEXTERNAL CREDIT RATINGSFACE VALUEFEDERAL NATIONAL MORTGAGE ASSOCIATIONFEDERAL RESERVEFINANCIAL CRISESFINANCIAL CRISISFINANCIAL FRAGILITYFINANCIAL HISTORYFINANCIAL INSTABILITYFINANCIAL INSTITUTIONFINANCIAL INSTITUTIONSFINANCIAL INSTRUMENTSFINANCIAL MARKETSFINANCIAL REGULATIONFINANCIAL SAFETY NETSFINANCIAL STABILITYFINANCIAL SYSTEMFINANCIAL SYSTEMSFOREIGN EXCHANGEFOREIGN EXCHANGE RISKFOREIGN MARKETSFORMS OF DEBTFUND MANAGERSGLOBAL MARKETSGLOBALIZATIONHEDGE FUNDHEDGE FUND MANAGERSHEDGE FUNDSHOLDINGSHOME LOANHOME OWNERSHIPHOST COUNTRIESHOUSINGHOUSING PRICESILLIQUIDITYIMPLICIT SUBSIDIESINDIVIDUAL BONDINDIVIDUAL LOANSINFLATIONINFORMATION SYSTEMINFORMATION SYSTEMSINSURANCEINSURANCE COMPANIESINSURANCE COMPANYINTANGIBLEINTEREST RATEINTEREST RATESINTEREST-RATE RISKINTERNATIONAL BANKINTERNATIONAL FINANCEINVESTINGINVESTMENT BANKINVESTMENT BANKINGINVESTMENT BANKSINVESTMENT STRATEGYINVESTMENT VEHICLEINVESTOR LOSSINVESTOR RETURNSISSUANCELENDERLENDERSLINES OF CREDITLIQUIDITYLIQUIDITY CRISISLIQUIDITY PROBLEMLIQUIDITY RISKLOAN APPLICATIONSLOAN MARKETSLOAN OFFICERSLOAN PORTFOLIOLOAN QUALITYLONG-TERM INTERESTLOSS OF CONFIDENCEMARK-TO-MARKETMARK-TO-MARKET ACCOUNTINGMARKET DISCIPLINEMARKET FOR CREDITMARKET INTEREST RATESMARKET LIQUIDITYMARKET OVERSIGHTMARKET PARTICIPANTSMARKET PRACTICESMARKET RISKMARKET RISKSMARKET STRUCTUREMARKET VALUESMATURITIESMATURITYMATURITY TRANSFORMATIONMINIMUM CAPITAL REQUIREMENTSMONETARY POLICYMORTGAGEMORTGAGESMUNICIPALITIESNEW ENTRANTSOIL PRICESOLIGOPOLISTIC MARKETOUTPUT LOSSPENSIONPENSION FUNDSPORTFOLIOPORTFOLIOSPRIVATE PARTIESPROBABILITY OF DEFAULTPRUDENTIAL REGULATIONPRUDENTIAL SUPERVISIONREGULATORY FORBEARANCEREGULATORY STANDARDSREGULATORY SYSTEMSRESERVESRETURNRISK CONTROLSRISK EXPOSURERISK EXPOSURESRISK MANAGEMENTRISK PREMIUMSRISKY LOANSSAFETY NETSAFETY NETSSECURITIESSHAREHOLDERSHAREHOLDER EQUITYSHAREHOLDERSSHORT-TERM DEBTSIMPLE BONDSTOCK OPTIONSSTUDENT LOANSSUBORDINATED DEBTSUPERVISORY AUTHORITIESSUPERVISORY AUTHORITYTAXTRADINGTRANCHETRANCHESTRANSACTIONTRANSACTION COSTSTRANSFER RISKTRANSPARENCYUNDERLYING ASSETUNDERLYING ASSETSUNDERLYING MORTGAGESVALUATIONVALUATIONSWAREHOUSEWRITEDOWNSWorld Bank10.1596/1813-9450-4756