Regulatory Reform, Stability, and Central Banking

by Sabrina I. Pacifici on February 4, 2014

Hutchins Center on Fiscal and Monetary Policy – Brookings - Paul Tucker Harvard Kennedy School and Business School January 16, 2014

“…Although at times preoccupied with local reform debates, the capitals of the world’s major economies confronted common issues in redrawing the rules of the road for finance. Combined with a shared desire to preserve open, global financial markets, this has meant the main reform action has been international—perhaps more so than is recognised here in the United States or in London. Overall, the test is whether the reforms can increase the resilience of the system as a whole, reduce contagion when trouble hits, and mitigate the pro-cyclicality of financial conditions. Broadly, the banking package is coherent and well-conceived, seeking to address excess leverage, excess opacity, excess interconnectedness, excess maturity mismatches, as well as the biggest issue of all: too big to fail. The aim is to apply its key elements not only to de jure banks, but also to any important institutions that are leveraged and exposed to liquidity runs. Higher solvency requirements and a credible regime for resolving distressed firms will, taken together, both reduce the risk of panicky liquidity runs and, in the event that a run does occur, make it easier to restore order without a bailout. This paper’s evaluation begins, therefore, with the four core planks of the  international reform effort, which is broadly consistent with the Dodd-Frank legislation in the United States:

• Strengthening the balance sheets of banks, and revitalising prudential supervision
• Ensuring that distress at any financial institution can be resolved in an orderly way without taxpayer solvency support, i.e., no bailouts
• Guarding against endemic regulatory arbitrage undermining those efforts, so that shadow banking is not left free to blow up the financial system at some point in the future
• Simplifying the network of counterparty credit exposures amongst banks and dealers, through mandated use of central counterparties (CCPs) for standard derivatives.”

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