A macroprudential perspective on regulating large financial institutions

One of the many lessons to be drawn from the recent financial crisis is that a macroprudential perspective must be brought to bear on the regulation of large financial institutions. This macroprudential perspective suggests two kinds of policy measures, over and above the strengthening of capital and liquidity regulation applicable to all banks. First, the negative externalities that the distress or failure of such institutions can impose on the financial system as a whole should be addressed through progressively stricter regulatory measures to increase the resiliency of the largest firms. Capital surcharges, total loss absorbency requirements, and charges for use of large amounts of short-term funding are examples. Second, the collective impact of changes in the condition of these large institutions on the real economy should be taken into account in regulatory requirements and expectations. Thus, for example, supervisory stress tests should be constructed so as to reflect the potential macroeconomic impact of losses or balance sheet adjustments at large firms as a whole in the face of adverse scenarios. The international community has made a good start in developing regulatory measures motivated by macroprudential considerations. However, there remains considerable work to be done, particularly in addressing the potential for contagion presented by the use of short-term wholesale funding.