Preventing Future Crises
The financial crisis has exposed weaknesses in the current regulatory and supervisory frameworks. The recent developments have made it clear that action is needed in at least four areas to reduce the risk of crises and address them when they occur. These are (a) finding a better way to assess systemic risk and prevent its buildup in good times; (b) improving transparency and disclosure of risks being taken by various market participants; (c) expanding the cross-institutional and cross-border scope of regulation while safeguarding constructive diversity; and (d) putting in place mechanisms for more effective, coordinated actions.
Effective regulation is needed to realize the potential of open financial markets. How to improve regulation was central to the discussion at the November G-20 Summit on Financial Markets and the World Economy. Financial innovation and integration have increased the speed and extent to which shocks are transmitted across asset classes and countries, blurring boundaries between systemic and nonsystemic institutions. But regulation and supervision have remained geared toward individual financial institutions. The regulatory mechanisms do not adequately consider the systemic and international implications of domestic institutions’ actions.
This article takes a look at substantive issues in the current debates on reforming the financial sector. The first section identifies crucial weaknesses that the reforms need to address, and the second outlines key areas for policy action.
What went wrong
Reform proposals should address destabilizing failures in markets and regulation. Although the jury is still out, three groups of mutually reinforcing factors that did not receive adequate attention from regulators ...