A “gobsmacking” weakness in the way banks are regulated led to the current financial crisis, the OECD says today. The club of rich nations, in its twice-yearly financial review, blasted the regulatory framework as “very poor” because not only did it fail to prevent the crisis but also contributed to it.

One of the key triggers was the introduction of a new regime for supervising all banks, the Basle II regime, which significantly boosted the attrac-tiveness to banks of lending money secured on residential property.

That led to a rise in loans to sub-prime borrowers, which were then packaged into securities and sold to institutions. The OECD traced the roots of the problem to 2004, when there was “a veritable explosion” in residential mortgage-backed securities, presaged by four events.

The first was President Bush’s “American Dream” proposals to make it easier for poor Americans to obtain mortgages. Second was the tougher capital requirements imposed on the mortgage finance groups Freddie Mac and Fannie Mae, which triggered an invasion of banks into their territory. Third was the transition towards Basle II, which made mortgage lending more attractive and fostered the creation of off-balance sheet vehicles. The final element was a policy shift by the Securities and Exchange Commission, which allowed investment banks to increase their leverage from about 15 to one to as much as 40 to one.

Adrian Blundell-Wignall, an OECD official, wrote: “One of the ‘gobsmacking’ assumptions of basic capital regulation under the Basle system is something called ‘portfolio invariance’.” This assumed that the riskiness of an asset class, such as a mortgage, was independent of how much of it was held in a portfolio.

The OECD also blamed “a massive failure in corporate governance”, the bank bonus culture, the credit-rating agencies and the lack of due diligence by institutional investors for exacerbating the crisis.

The criticisms come as policy-makers begin the task of hammering together a new regulatory regime to prevent a repeat of the credit crunch. This week Alistair Darling, the Chancellor, wrote to fellow G20 finance ministers saying that the status quo was unacceptable and that they had to come up with specific solutions.

Next week in the UK, the International Centre for Financial Regulation, a Treasury-backed forum, is launched.

Shortcomings in risk management, bonus schemes, governance structures, liquidity and counterparty risk need to be addressed, the OECD said.

The organisation also put a figure on the colossal destruction of wealth that followed the credit crunch: $3,068 billion (£2,018 billion) was wiped from the stock market value of banks in the course of 2008, it said.

Mouthing off

— Gobsmacked [adj, Brit slang: astounded; astonished] is a fairly recent addition to the British vernacular.

— It did not grace the pages of The Times until 1989, let alone feature in sombre inter-governmental reports.

— It derives from combining “gob”, in turn thought to owe its origins to Scots gaelic, and “smack”.

— To French delegates it may have been translated as sidéré, while the Dutch and German governments were no doubt verdattert at the regulatory lapses.

— The Spanish, whose banks were banned from dabbling in sub-prime derivatives, were almost certainly atónitos.

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