Rethinking financial regulation

In recent years, revolutionary changes in financial markets, combined with incidents such as Barings and Daiwa, have revived concerns about the adequacy of financial regulation. Historically, financial regulatory policy has been driven by the view that to maintain the health of the financial system you must maintain the health of individual institutions.> In light of ongoing changes in financial markets, however, extending the traditional approach to financial market regulation may not work. Extending the traditional approach may be too costly and difficult, especially for large, globally active institutions, because of the complexities of many new activities and financial instruments. Given these difficulties, it seems appropriate to ask whether there is an alternative regulatory approach to promoting financial stability and protecting government safety nets without sacrificing efficiency or stifling innovation.> In an article based on comments made at the annual World Economic Forum in Davos, Switzerland, Mr. Hoenig provides some thoughts on possible alternatives. First, instead of regulating to make institutions fail-safe, an alternative approach would be to strengthen the stability of the financial system by designing procedures that prevent large interbank exposures in the payments system and interbank deposits. Second, although moral hazard problems can be contained through traditional regulatory approaches, an alternative would be to require those institutions that engage in an expanding array of complex activities to give up direct access to government safety nets in return for reduced regulation and oversight.