Tackling Systemic Financial Risk

Financial globalization helps individual market participants diversify risk, but need not stabilize the international financial system as a whole. Given increasingly complex financial innovations and interrelated markets, a shock in one particular market segment may trigger serious contagion in other segments.

Recently, the U.S. housing market decline and the subprime meltdown led to a proliferation of financial risks in other financial markets and sectors worldwide. What policies are required to deal with the problem that the diversification of credit risk reduces the incentive of creditors to scrutinize borrowers? Is it sufficient to rely on voluntary codes of conduct by hedge funds, or should they be regulated either directly or indirectly? Which kind of regulatory and supervisory approaches (rules versus discretion) are most promising? What are the appropriate strategies for fighting a major financial cross-border crisis effectively, once crisis prevention has failed or reached its limits?

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Tackling Systemic Financial Risk