A systemic approach to financial regulation – A European perspective

The global financial crisis has pinpointed the relevance and the virulence of systemic risk in […]

Policy Study

09/10/2014

The global financial crisis has pinpointed the relevance and the virulence of systemic risk in modern innovative finance. It is grounded in the propensity of credit markets to drift to extremes in close correlation with asset price spikes and slumps. In turn, such a propensity is nurtured by the heuristic behaviour of market participants under severe uncertainty. While plagued by disaster myopia, market participants spread systemic risk. Such adverse conditions have been magnified by financial innovations that have made finance predatory and capable of capturing regulators to annihilate prudential policies.

Malfunctioning in finance is so deep and disorders are so widespread that sweeping reforms are the order of the day, if financial stability is viewed as a primary public concern. In this paper we argue that macro prudential policy should be the linchpin of relevant reforms. Being a top-down approach, it impinges both upon monetary policy and micro prudential policy.

Central banks should pursue a dual objective of price and financial stability. Bank supervisors should broaden their oversight on a much larger perimeter, encompassing all systematically important institutions. Counter cyclical capital provisions should be required and linked to the control of aggregate credit supply. Leveraged institutions without deposit base should be subject to incentives for a much stricter liquidity management. To stem regulatory capture, prompt corrective action should be enlarged in its scope and adapted to mark-to-market financial intermediaries.

Implementing macro prudential policy entails institutional changes. Central banks, bank supervisors and other financial regulators need to work much closer than beforehand, because the spread of systemic risk is not deterred by institutional and geographical frontiers. The changes to make are particularly stringent in Europe, where national parochialism makes the resolution of orderly cross-border bank crisis all but impossible.

Read the study made for FEPS by Michel AGLIETTA, Professor of Economics at the University of Paris X-Nanterre and Scientific Advisor at CEPII, and Laurence SCIALOM, Professor of Economics at the University of Paris X-Nanterre

Find all related publications
Publications
06/07/2022

Countering economic coercion: how can the European Union succeed?

This policy brief assesses how the EU can bolster its response and defence mechanisms against […]
06/07/2022

Leveraging trade policy for the EU’s strategic autonomy

In a context of increasing weaponisation of interdependence – highlighted by the pandemic and Russia’s […]
04/07/2022

Partnerships and European strategic autonomy: How to turn them into a win-win approach

To become more strategic and autonomous, the European Union has to better use its global […]
28/06/2022

Sustainable Digital Market Design: A data-based approach to the circular economy

Markets must be designed properly to serve the common good. This is particularly evident in […]
Find all related news
News
21/06/2022

Ahead of this week’s European Council, progressive MEPs and MPs urge EU leaders to take resolute actions toward the Western Balkans

On 17 and 18 June, the ‘Friends of the Western Balkans’, the newly established network […]
17/06/2022

First meeting of the Friends of the Western Balkans

How do we get out of the dead end in the enlargement process?
10/06/2022

FEPS launches a new website!

After months of work, FEPS’s new website is now online!  This new website offers a […]
09/06/2022

FEPS holds the 2022 General Assembly

This week, FEPS held the 2022 General Assembly (GA), the yearly meeting gathering all members […]
Find all related in the media
In the media

Leaders Must Choose a Just Energy Transition and a Social Europe

by Euractiv 30/05/2022

The circular economy and green jobs

by ENCOMPASS 25/05/2022

Da Prodi a Rodrigues, domani al via la ’Terza conferenza sul futuro dell’Europa’

by La Nazione 25/05/2022

Visioni e strategie per disegnare il futuro europeo 

by La Nazione 23/05/2022