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

  • Larry D. Wall

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.

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Paper provided by Federal Reserve Bank of Atlanta in its series FRB Atlanta Working Paper with number 2010-09.

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Date of creation: 2010
Date of revision:
Handle: RePEc:fip:fedawp:2010-09
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  1. Luigi Zingales & Oliver Hart, 2009. "A New Capital Regulation For Large Financial Institutions," Working Papers 2009.124, Fondazione Eni Enrico Mattei.
  2. Larry D. Wall & Robert A. Eisenbeis, 1999. "Financial regulatory structure and the resolution of conflicting goals," FRB Atlanta Working Paper 99-12, Federal Reserve Bank of Atlanta.
  3. 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, vol. 4(3), pages 232-257, September.
  4. Lawrence J. White & W. Scott Frame, 2009. "The Federal Home Loan Bank System: Current Issues in Perspective," Working Papers 09-18, New York University, Leonard N. Stern School of Business, Department of Economics.
  5. 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.
  6. Kristopher Gerardi & Andreas Lehnert & Shane M. Sherlund & Paul Willen, 2008. "Making Sense of the Subprime Crisis," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 39(2 (Fall)), pages 69-159.
  7. Raghuram G. Rajan, 2009. "The credit crisis and cycle-proof regulation," Review, Federal Reserve Bank of St. Louis, issue Sep, pages 397-402.
  8. Adam B. Ashcraft & Morten L. Bech & W. Scott Frame, 2009. "The Federal Home Loan Bank System: the lender of next-to-last resort?," FRB Atlanta Working Paper 2009-04, Federal Reserve Bank of Atlanta.
  9. Carlos O. Arteta & Mark S. Carey & Ricardo Correa & Jason Kotter, 2013. "Revenge of the steamroller: ABCP as a window on risk choices," International Finance Discussion Papers 1076, Board of Governors of the Federal Reserve System (U.S.).
  10. 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.
  11. Kane, Edward J, 1977. "Good Intentions and Unintended Evil: The Case against Selective Credit Allocation," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 9(1), pages 55-69, February.
  12. Larry D. Wall, 1986. "Nonbank activities and risk," Economic Review, Federal Reserve Bank of Atlanta, issue Oct, pages 19-34.
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