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Prudential discipline for financial firms: micro, macro, and market structures

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  • Larry D. Wall

Abstract

The recent global financial crisis reflects numerous breakdowns in the prudential discipline of financial firms. This paper discusses ways to strengthen micro- and macroprudential supervision and restore credible market discipline. The discussion notes that microprudential supervisors are typically assigned a variety of goals that sometimes have conflicting policy implications. In such a setting, the structure of the regulatory agencies and the priority given to prudential goals are critical to achieving those goals. ; The analysis of macroprudential supervision emphasizes that this supervisor must be both bold and modest: bold in seeking to understand the sources and distributions of systemically important risks and modest about what a supervisor can do without imposing overly restrictive regulations. ; Finally, the paper argues that the primary responsibility for risk management must rest with firms, not government supervisors. Unfortunately, systemic risk concerns have led governments to shield the private sector from the full losses that dull their incentive to discipline risk taking. This section of the paper suggests that deposit insurance reform, special resolutions for systemically important firms, and requirements that firms plan for their own resolution and contingent capital may all have a role to play in restoring effective market discipline.

Suggested Citation

  • Larry D. Wall, 2010. "Prudential discipline for financial firms: micro, macro, and market structures," FRB Atlanta Working Paper 2010-09, Federal Reserve Bank of Atlanta.
  • Handle: RePEc:fip:fedawp:2010-09
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    References listed on IDEAS

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    5. Manuel Adelino & Kristopher S. Gerardi & Paul S. Willen, 2010. "What explains differences in foreclosure rates?: a response to Piskorski, Seru, and Vig," Working Papers 10-2, Federal Reserve Bank of Boston.
    6. Larry Wall & Robert Eisenbeis, 1999. "Financial Regulatory Structure and the Resolution of Conflicting Goals," Journal of Financial Services Research, Springer;Western Finance Association, pages 223-245.
    7. Adam Ashcraft & Morten L. Bech & W. Scott Frame, 2010. "The Federal Home Loan Bank System: The Lender of Next-to-Last Resort?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 42(4), pages 551-583, June.
    8. Larry D. Wall, 1986. "Nonbank activities and risk," Economic Review, Federal Reserve Bank of Atlanta, pages 19-34.
    9. Gillian G.H. Garcia & Rosa M. Lastra & María J. Nieto, 2009. "Bankruptcy and reorganization procedures for cross-border banks in the EU: Towards an integrated approach to the reform of the EU safety net," Journal of Financial Regulation and Compliance, Emerald Group Publishing, vol. 17(3), pages 240-276, July.
    10. James J. McAndrews & William Roberds, 1999. "Payment intermediation and the origins of banking," Staff Reports 85, Federal Reserve Bank of New York.
    11. Mayes, David G. & Nieto, María J. & Wall, Larry, 2008. "Multiple safety net regulators and agency problems in the EU: Is Prompt Corrective Action partly the solution?," Journal of Financial Stability, Elsevier, pages 232-257.
    12. J. Gruber & B. Mandel & M. Del Gatto & F. Di Mauro, 2012. "The "Revealed" Competitiveness of U.S. Exports," Working Paper CRENoS 201232, Centre for North South Economic Research, University of Cagliari and Sassari, Sardinia.
    13. Gillian G.H.Garcia & Rosa M. Lastra & Maria J. Nieto, 2009. "Bankruptcy and reorganisation procedures for cross-border banks in the EU: Towards an integrated approach to the reform of the EU safety net," FMG Special Papers sp186, Financial Markets Group.
    14. Oliver Hart & Luigi Zingales, 2011. "A New Capital Regulation for Large Financial Institutions," American Law and Economics Review, Oxford University Press, vol. 13(2), pages 453-490.
    15. Santiago Carbó-Valverde & Francisco Rodríguez-Fernández & Gregory F. Udell, 2009. "Bank Market Power and SME Financing Constraints," Review of Finance, European Finance Association, pages 309-340.
    16. Wall, Larry D., 2009. "Prudential Discipline for Financial Firms: Micro, Macro, and Market Structures," ADBI Working Papers 176, Asian Development Bank Institute.
    17. Mayes, David G. & Nieto, María J. & Wall, Larry, 2008. "Multiple safety net regulators and agency problems in the EU: Is Prompt Corrective Action partly the solution?," Journal of Financial Stability, Elsevier, pages 232-257.
    18. Larry D. Wall, 2010. "Prudential Discipline for Financial Firms: Micro, Macro, and Market Structures," Working Papers id:3040, eSocialSciences.
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    Cited by:

    1. Manuel Adelino & Kristopher S. Gerardi & Paul S. Willen, 2010. "What explains differences in foreclosure rates?: a response to Piskorski, Seru, and Vig," Working Papers 10-2, Federal Reserve Bank of Boston.
    2. Jérôme Coffinet & Adrian Pop & Muriel Tiesset, 2013. "Monitoring Financial Distress in a High-Stress Financial World: The Role of Option Prices as Bank Risk Metrics," Journal of Financial Services Research, Springer;Western Finance Association, pages 229-257.
    3. Larry D. Wall, 2010. "Prudential Discipline for Financial Firms: Micro, Macro, and Market Structures," Working Papers id:3040, eSocialSciences.
    4. Jérôme Coffinet & Adrian Pop & Muriel Tiesset, 2010. "Predicting Financial Distress in a High-Stress Financial World: The Role of Option Prices as Bank Risk Metrics," Working Papers hal-00547744, HAL.
    5. David G. Mayes, 2012. "Moral Hazard, Bank Resolution and the Protection of Depositors," Chapters,in: Research Handbook on International Banking and Governance, chapter 14 Edward Elgar Publishing.
    6. Larry D. Wall, 2012. "Central banking for financial stability Some lessons from the recent instability in the US and euro area," Public Policy Review, Policy Research Institute, Ministry of Finance Japan, vol. 8(3), pages 247-280, August.
    7. Wall, Larry D., 2009. "Prudential Discipline for Financial Firms: Micro, Macro, and Market Structures," ADBI Working Papers 176, Asian Development Bank Institute.
    8. Larry D. Wall, 2012. "Enlisting Macroprudential and Market Regulatory Structures to Strengthen Prudential Supervision," Chapters,in: Implications of the Global Financial Crisis for Financial Reform and Regulation in Asia, chapter 3 Edward Elgar Publishing.
    9. Wall, Larry D., 2012. "Central Banking for Financial Stability: Some Lessons from the Recent Instability in the United States and Euro Area," ADBI Working Papers 379, Asian Development Bank Institute.
    10. Reza Siregar & Lim, C.S. Vincent, 2011. "Living with Macro-financial Linkages: Policy Perspectives and Challenges for SEACEN Countries," Staff Papers, South East Asian Central Banks (SEACEN) Research and Training Centre, number sp79, April.
    11. Robert N. Collender & Forrest W. Pafenberg & Robert S. Seiler, Jr., 2010. "Automatic Recapitalization Alternatives," Staff Working Papers 10-02, Federal Housing Finance Agency.
    12. David G. Mayes, 2009. "Banking Crisis Resolution Policy - Lessons from Recent Experience - which elements are needed for robust and efficient crisis resolution?," CESifo Working Paper Series 2823, CESifo Group Munich.

    More about this item

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • K23 - Law and Economics - - Regulation and Business Law - - - Regulated Industries and Administrative Law

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