Change and constancy in the financial system: implications for financial distress and policy
AbstractOver the past three decades, the financial system has been going through a historical phase of major structural change. This paper traces the implications of this financial revolution for the dynamics of financial distress and for policy. It argues that, despite this revolution, some fundamental characteristics of the financial system have not changed and that these hold the key to the dynamics of financial instability. These characteristics relate to imperfect information in financial contracts, to risk perceptions and incentives, and to powerful feedback mechanisms operating both within the financial system and between that system and the macro-economy. As a result, the primary cause of financial instability has always been, and will continue to be, overextension in risk-taking and balance-sheets. The challenge is to design a policy response that is firmly anchored to the more enduring features of financial instability while at the same time tailoring it to the evolving financial system. Using an analogy with road safety, policy has so far largely focused quite effectively on improving the state of the roads and on introducing buffers. More attention, however, could usefully be devoted to the design and implementation of speed limit.
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Bibliographic InfoPaper provided by Bank for International Settlements in its series BIS Working Papers with number 237.
Length: 27 pages
Date of creation: Oct 2007
Date of revision:
Financial revolution; financial instability; risk; liquidity; financial regulation; speed limits;
Other versions of this item:
- Claudio Borio, 2007. "Change and Constancy in the Financial System: Implications for Financial Distress and Policy," RBA Annual Conference Volume, in: Christopher Kent & Jeremy Lawson (ed.), The Structure and Resilience of the Financial System Reserve Bank of Australia.
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