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A systemic approach to financial regulation: a European perspective

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  • Michel Aglietta
  • Laurence Scialom

Abstract

The global financial crisis has pinpointed the relevance and the virulence of systemic risk in modern innovative finance. It is grounded in the propensity of credit markets to drift to extremes in close correlation with asset price spikes and slumps. In turn, such a propensity is nurtured by the heuristic behaviour of market participants under severe uncertainty. While plagued by disaster myopia, market participants spread systemic risk. Such adverse conditions have been magnified by financial innovations that have made finance predatory and capable of capturing regulators to annihilate prudential policies. Malfunctioning in finance is so deep and disorders are so widespread that sweeping reforms are the order of the day, if financial stability is viewed as a primary public concern. In this paper we argue that macro prudential policy should be the linchpin of relevant reforms. Being a top-down approach, it impinges both upon monetary policy and micro prudential policy. Central banks should pursue a dual objective of price and financial stability. Bank supervisors should broaden their oversight on a much larger perimeter, encompassing all systematically important institutions. Counter cyclical capital provisions should be required and linked to the control of aggregate credit supply. Leveraged institutions without deposit base should be subject to incentives for a much stricter liquidity management. To stem regulatory capture, prompt corrective action should be enlarged in its scope and adapted to mark-to-market financial intermediaries. Implementing macro prudential policy entails institutional changes. Central banks, bank supervisors and other financial regulators need to work much closer than beforehand, because the spread of systemic risk is not deterred by institutional and geographical frontiers. The changes to make are particularly stringent in Europe, where national parochialism makes the resolution of orderly cross-border bank crisis all but impossible.

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Paper provided by University of Paris West - Nanterre la Défense, EconomiX in its series EconomiX Working Papers with number 2009-29.

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Length: 35 pages
Date of creation: 2009
Date of revision:
Handle: RePEc:drm:wpaper:2009-29

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  1. Tobias Adrian & Hyun Song Shin, 2008. "Liquidity, monetary policy, and financial cycles," Current Issues in Economics and Finance, Federal Reserve Bank of New York, Federal Reserve Bank of New York, vol. 14(Jan).
  2. Dimitrios P Tsomocos & Charles A.E. Goodhart, 2004. "A Risk Assessment Model for Banks," Economics Series Working Papers 2004-FE-11, University of Oxford, Department of Economics.
  3. Con Keating & Hyun Song Shin & Charles Goodhart & Jon Danielsson, 2001. "An Academic Response to Basel II," FMG Special Papers, Financial Markets Group sp130, Financial Markets Group.
  4. Martin Hellwig, 2009. "Systemic Risk in the Financial Sector: An Analysis of the Subprime-Mortgage Financial Crisis," De Economist, Springer, Springer, vol. 157(2), pages 129-207, June.
  5. Robert A. Eisenbeis & George G. Kaufman, 2005. "Bank crisis resolution and foreign-owned banks," Economic Review, Federal Reserve Bank of Atlanta, Federal Reserve Bank of Atlanta, issue Q4, pages 1-18.
  6. Dewatripont, M. & Rochet, JC., 2009. "The treatment of distressed banks," Financial Stability Review, Banque de France, Banque de France, issue 13, pages 65-74, September.
  7. Robert A. Eisenbeis & George G. Kaufman, 2007. "Cross-border banking: challenges for deposit insurance and financial stability in the European Union," Working Paper, Federal Reserve Bank of Atlanta 2006-15, Federal Reserve Bank of Atlanta.
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Cited by:
  1. Augusto Hasman, 2013. "A Critical Review Of Contagion Risk In Banking," Journal of Economic Surveys, Wiley Blackwell, Wiley Blackwell, vol. 27(5), pages 978-995, December.

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