Regulation of Non-bank Institutions Essential for Stability
Regulating and insuring all “systemically significant” institutions, from banks to hedge funds, is essential to the future stability of financial markets, according to a new Working Paper* from Harvard Business School.
HBS Professor David Moss advocates a “Systemic Risk Review Board” that would have broad powers to collect information, both from other regulatory agencies and directly from financial institutions themselves.
His paper suggests that:
- Contrary to the prevailing wisdom, New Deal policies (including federal deposit insurance and bank supervision) worked to stabilize the financial system;
- The financial catastrophe of 2007-2009 was not an accident, but rather a mistake, driven by a deregulatory mindset that took 50 years of post-New Deal financial stability for granted; and
- The dramatic federal response to the current financial crisis has created a new reality, in which virtually all systemically significant financial institutions now enjoy an implicit guarantee from the federal government that will continue to exist (and continue to generate moral hazard) long after the immediate crisis passes.
Based on this analysis, one major step that is necessary now to help ensure financial stability in the future is to identify and regulate “systemically significant” institutions on an ongoing basis, rather than simply in the heat of a crisis.
“To guard against moral hazard (in the face of large implicit guarantees) and to ensure the safety of the broader financial system, these institutions must face significant prudential regulation, they should be required to pay premiums for the federal insurance they already enjoy, and they should be subject to an FDIC-style receivership process in the event of failure.”.
“Congress and the President should direct a new regulatory body or an existing regulatory agency to identify financial institutions whose failure would pose a systemic threat to the broader financial system (or would directly endanger “safe-zone” institutions such as commercial banks, pension funds, and insurance companies).”
“The regulatory body designated to make these determinations (call it a Systemic Risk Review Board) would have broad powers to collect information, both from other regulatory agencies and directly from financial institutions themselves. All financial institutions – from banks to hedge funds – would be required to report to this body, irrespective of other regulatory coverage.”
*An Ounce of Prevention: The Power of Public Risk Management in Stabilizing the Financial System – David Moss
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