You are here: Home Knowledge Base Economy Strengthening the Global Financial System Solutions Make bailouts come at a cost; tougher supervision and tighter capital standards are the price financial institutions have to pay for official rescue operations meant to stem systemic risk.
Symposium 2008

Solution for Strengthening the Global Financial System

The Challenge

The repeated reoccurrence of financial crises since the early 1990s has led to calls for institutional reform. The most recent example is the crisis that began with the problems on the subprime segm ...

The repeated reoccurrence of financial crises since the early 1990s has led to calls for institutional reform. The most recent example is the crisis that began with the problems on the subprime segment of the US housing market. Numerous commentators have observed that the interactions between commercial banks, other financial intermediaries, credit rating agencies, financial regulators, national banks and governments were partly responsible for the financial unrest. There is a need for better management and regulation of diverse, interrelated risks.

Make bailouts come at a cost; tougher supervision and tighter capital standards are the price financial institutions have to pay for official rescue operations meant to stem systemic risk.

Central banks should be cautious in bailing out financial institutions. Considering that highly leveraged institutions have increasingly been rescued recently (for reasons of being “too big to fail”), the still relatively narrow regulatory domain needs to be aligned with the expanded domain of liquidity support by central banks. Clearly, the principle to be applied in normal times for isolated failures has to be distinguished from crisis management measures.

Governments often impose only soft constraints as a quid pro quo for capital injections. Thus, the shareholders often retain their capital and the managers remain in place, even as they receive taxpayers´ capital.

Shareholders should lose part of their capital and the management be replaced, to reduce moral hazard. But this measure alone is insufficient, since it leaves the financial system undercapitalized. Furthermore, it appears that stockholders often exert little discipline on financial institutions, even when workers own a large share of them. Thus, government capital injections should be accompanied by burden sharing with debt holders and other counterparties.

    Related Solutions

    Solution
    Symposium 2008

    Enhance transparency by standardization of complex financial contracts and shifting the trading of derivatives onto regulated exchanges.

    Enhance transparency by standardization of complex financial contracts and shifting the trading of derivatives onto regulated exchanges.

    Enhance transparency by standardization of complex financial contracts and shifting the trading of derivatives onto regulated exchanges.

    Polity, Business
    Solution
    Symposium 2008

    Strengthen regulation and supervision of all systemically relevant financial institutions – both in the banking and shadow-banking sectors – but avoid regulatory overkill by focusing on simple rules on capital ...

    Strengthen regulation and supervision of all systemically relevant financial institutions – both in the banking and shadow-banking sectors – but avoid regulatory overkill by focusing on simple rul ...

    Strengthen regulation and supervision of all systemically relevant financial institutions – both in the banking and shadow-banking sectors – but avoid regulatory overkill by focusing on simple rules on capital adequacy.

    Polity
    Solution
    Symposium 2008

    Address the procyclicality of the financial and regulatory system by adjusting mark-to-market accounting and by introducing flexible capital adequacy requirements.

    Address the procyclicality of the financial and regulatory system by adjusting mark-to-market accounting and by introducing flexible capital adequacy requirements.

    Address the procyclicality of the financial and regulatory system by adjusting mark-to-market accounting and by introducing flexible capital adequacy requirements.

    Polity, Business
    Solution
    Symposium 2008

    Eliminate conflicts of interest and promote competition in the credit rating market.

    Eliminate conflicts of interest and promote competition in the credit rating market.

    Eliminate conflicts of interest and promote competition in the credit rating market.

    Polity, Business
    Solution
    Symposium 2008

    Replace the Basel II accord, in order to ensure systemic stability by factoring both illiquidity and insolvency risks into capital adequacy requirements and to deprive credit rating agencies of their ...

    Replace the Basel II accord, in order to ensure systemic stability by factoring both illiquidity and insolvency risks into capital adequacy requirements and to deprive credit rating agencies of their ...

    Replace the Basel II accord, in order to ensure systemic stability by factoring both illiquidity and insolvency risks into capital adequacy requirements and to deprive credit rating agencies of their regulatory influence.

    Polity, Business
    Solution
    Symposium 2008

    Gear monetary policy towards price stability first and foremost but, to avoid asset price bubbles, leave open the possibility of “leaning against the wind.”

    Gear monetary policy towards price stability first and foremost but, to avoid asset price bubbles, leave open the possibility of “leaning against the wind.”

    Gear monetary policy towards price stability first and foremost but, to avoid asset price bubbles, leave open the possibility of “leaning against the wind.”

    Polity