Setting the Stage for Regulatory Reform in the Aftermath of the Recent Financial Crisis
Dr. Gioia Pescetto, Canterbury Christ Church University, UK
Abstract: Banks are essential and sophisticated mechanisms in the engine of the global economy. They are strictly regulated institutions, which most of the time function like clockwork. So, what went wrong in 2007/08? During the preceding period of economic boom, the share of assets outside the traditional banking system had grown very rapidly, and the so-called "shadow banking system" had come to play a critical role in providing credit across the global financial system. It has been estimated that in early 2007 lending through the shadow banking system slightly exceeded lending via traditional banking operations. In the US in particular, cheap money caused a housing bubble; as banks tried to reduce their exposure to their riskier mortgages via securitization, in effect they increased the risk in the system by transferring mortgages to investors who did not know their customers; AAA-rated "synthetic" securities backed assets that were not AAA-rated; and a serious maturity mis-match arose in the system as a whole. At the first signs of the crisis in 2007, the financial system started to unravel with a speed that nobody had predicted. The global regulatory failure has its root in the micro approach to financial regulation. It is now obvious that by regulating individual banks not only the stability of the system is not protected, but systemic risk may actually worsen. As we reflect on the recent financial crisis, we need to consider a macro-prudential approach to financial regulation, which is fit for the globalised financial system and is sensitive to the needs of emerging markets.
