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Prudential Discipline for Financial Firms: Micro, Macro, and Market Structures

  • Wall, Larry D.

    (Asian Development Bank Institute)

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 with 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 requiring firms to plan for their own resolution and contingent capital may all have a role to play in restoring effective market discipline.

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File URL: http://www.adbi.org/working-paper/2009/12/10/3401.prudential.discipline.financial.firms/
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Paper provided by Asian Development Bank Institute in its series ADBI Working Papers with number 176.

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Length: 33 pages
Date of creation: 10 Dec 2009
Date of revision:
Handle: RePEc:ris:adbiwp:0176
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  1. 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, 06.
  2. Carlos Arteta & Mark 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.).
  3. Larry D. Wall, 1986. "Nonbank activities and risk," Economic Review, Federal Reserve Bank of Atlanta, issue Oct, pages 19-34.
  4. Kristopher S. Gerardi & Andreas Lehnert & Shane M. Sherlund & Paul S. Willen, 2009. "Making sense of the subprime crisis," Public Policy Discussion Paper 09-1, Federal Reserve Bank of Boston.
  5. 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.
  6. Larry D. Wall & Robert A. Eisenbeis, 1999. "Financial regulatory structure and the resolution of conflicting goals," Working Paper 99-12, Federal Reserve Bank of Atlanta.
  7. Kenneth Lehn, 1999. "Comments on “Financial Regulatory Structure and the Resolution of Conflicting Goals”," Journal of Financial Services Research, Springer, vol. 16(2), pages 247-248, December.
  8. Rajan, Raghuram G., 2013. "The Credit Crisis and Cycle-Proof Regulation," Review, Federal Reserve Bank of St. Louis, issue Nov, pages 461-467.
  9. 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.
  10. Gillian G.H. Garcia, 2009. "Ignoring the lessons for effective prudential supervision, failed bank resolution and depositor protection," Journal of Financial Regulation and Compliance, Emerald Group Publishing, vol. 17(3), pages 186-209, July.
  11. 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.
  12. 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.
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