Coping with Systemic Risk
The global financial crisis has revealed how systemic risk in the banking system can lead to huge economic downturns. Many of the problems leading to the crisis have been discussed and many suspects have been identified (including investment banks, central banks, rating agencies, regulators and the economics profession).
But even with this detailed identification of problems in the financial system, remarkably little has been done to avoid future crises, with the notable exception of Basel III. It should be clear that changing capital requirements alone will be insufficient to stabilize financial markets and avoid future crises.
How should financial market stability be defined? Should central banks aim to monitor financial market stability and take action when necessary? What data are needed to monitor the system? Which stability-enhancing regulatory measures can be realistically implemented?
Should these measures be coordinated internationally to become effective or will national solutions suffice? Is there a risk of over-regulation in the reform process? How should the trade-off be made between the assumed benefits resulting from increased stability of the banking system and the potentially negative impact on global economic growth that will flow from regulatory changes? How is the financial industry likely to respond to these changes?