Procyclical and Short-Term Risk Measurement

The Great Recession of 2008 showed that risk modeling can be so deeply flawed as to allow banking officials to overlook entrenched banking instability. D’Arista and Griffith-Jones (2009) point out that the value-at-risk measurement is procyclical, and additional, non-cyclical measures of risk must be used. The value-at- iisk (VaR) measurement provides the probability that an asset or bundle of assets will decline by a particular amount over a given time period. Capital requirements given by VaR are inherently procyclical, since banks experience more losses during recessions than during booms, decreasing the lending capacity of the institution. Dodd-Frank and Basel III mandated changes that require countercyclical capital requirements (Kowalik 2011). The Basel III changes designate a buffer of 0-2.5 percent above the minimum capital requirements, while Dodd-Frank also includes countercyclical capital requirements and requirements that holding companies assist subsidiaries of insured depository institutions.

These are the major aspects of the current global financial architecture. As noted above, many changes within the world economic structure still need to be made, yet regulatory and institutional change has been ongoing. It will become apparent that institutional change in the face of financial instability is the only consistent feature of the global financial architecture.