Adjustments to the Basel-II framework for prudential control as suggested by the current financial crisis

Government initiatives to promote full employment are necessitated by downturns in private sector activity that are either triggered off or compounded by financial crises. As a new regulatory system designed for maintaining financial stability, Basel II has received endorsement from the financial industry for its characteristics of risk sensitivity and flexibility. However, other features may serve as a better explanation for this approval. These regulatory features of Basel II help to overcome the dichotomy between direct government command on one hand and self-regulation on the other. This paper will draw on two theoretical notions to evaluate Basel II; one of these is "reflexivity" (Aalders and Wilthagen, 1997), while the other is regulatory "responsiveness" (Braithwaite and Ayres, 1992). In evaluating the effectiveness of Basel II, the paper will examine changes that have occurred in the financial system including the use of CDOs, in the context of the subprime crisis.