I just read an interesting article on the history of Basel II, the set of rules that was established, some 25 years ago to make the supervisory rules for banking reflect more of the market dynamics than the previous set of rules. The article highlights that the zero-weighting prescribed for government banks, regardless of the country in which they were based, created a bias that made banks upload tons of government treasuries of a range of countries. It made banks lazy in doing a check on the counterparty risk, although there were serious differences in the quality of the debt. And it thus also provided easy (and cheap) money for the governments. We have since learnt that that is not a good thing and that governments cannot keep on borrowing money forever. See also todays warning and possible USA downgrade by Moodys.
The author of the article outlines that at this moment we can see the European Central Bank ignoring the rating agencies qualifications of countries debt to be able to continue providing liquidity to Portuguese and Irish banks. And he goes on to outline that it is quite likely that the future will consist of different Basel-rules, in which banks will have to do better due diligence and have to use realistic measures for counterparty risks.
That is, if we are willing to learn from history.
