Containing Systemic Risk : Paradigm-Based Perspectives on Regulatory Reform
Financial crises can happen for a variety of reasons: (a) nobody really understands what is going on (the collective cognition paradigm); (b) some understand better than others and take advantage of their knowledge (the asymmetric information paradigm); (c) everybody understands, but crises are a natural part of the financial landscape (the costly enforcement paradigm); or (d) everybody understands, yet no one acts because private and social interests do not coincide (the collective action paradigm). The four paradigms have different and often conflicting prudential policy implications. This paper proposes and discusses three sets of reforms that would give due weight to the insights from the collective action and collective cognition paradigms by redrawing the regulatory perimeter to internalize systemic risk without promoting dynamic regulatory arbitrage; introducing a truly systemic liquidity regulation that moves away from a purely idiosyncratic focus on maturity mismatches; and building up the supervisory function while avoiding the pitfalls of expanded official oversight.
Summary: | Financial crises can happen for a
variety of reasons: (a) nobody really understands what is
going on (the collective cognition paradigm); (b) some
understand better than others and take advantage of their
knowledge (the asymmetric information paradigm); (c)
everybody understands, but crises are a natural part of the
financial landscape (the costly enforcement paradigm); or
(d) everybody understands, yet no one acts because private
and social interests do not coincide (the collective action
paradigm). The four paradigms have different and often
conflicting prudential policy implications. This paper
proposes and discusses three sets of reforms that would give
due weight to the insights from the collective action and
collective cognition paradigms by redrawing the regulatory
perimeter to internalize systemic risk without promoting
dynamic regulatory arbitrage; introducing a truly systemic
liquidity regulation that moves away from a purely
idiosyncratic focus on maturity mismatches; and building up
the supervisory function while avoiding the pitfalls of
expanded official oversight. |
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