Designing Financial Sustainability
Garry Schinasi | Bruegel l January 2010
The United States and the European Union are establishing a series of new tools for ensuring financial control and preventing new financial crises. The EU is setting up a European Systemic Risk Board (ESRB) for macroprudential control and a European System of Financial Supervision (ESFS) for microprudential supervision. However, no financial early warning system can possibly function successfully, as long as a legislative framework for implementing measures to handle insolvency of systemically important financial institutions (SIFI) is lacking. Furthermore, central banks need greater powers to regulate financial markets.
The fact remains that the international financial crisis has discredited the existing supervisory and regulatory control framework. The system proved unable to detect the crisis in a timely fashion and much less prevent it, because it lacked the means to adapt to the latest developments in the financial markets. New early warning systems have to be modifiable and able to identify and observe sources of financial risks, and if necessary to diffuse them. The point is not only to recognize risks, but also to calculate their scope. The United States as well as Europe has plans to reform its financial systems. In order to face the financial crises of the future, both need to make sure that their central banks have the necessary instruments to assure monetary as well as financial stability. Moreover, over-the-counter derivates should no longer be traded bilaterally, but through multilateral central clearing houses. Furthermore, the relative advantages and costs of systemically important financial institutions ought to be reexamined. Several of these were considered too large to be effectively managed and in the end could only be saved by enormous financial injections of taxpayer money. This new agenda demands:
- Installing early warning mechanisms for prevention and problem resolution in order to facilitate the early and structured dissolution of faltering financial institutions.
- Preserving the independence of central banks so that these can implement monetary policies successfully.
- Providing the requisite authorizations and discretionary instruments to ensure the unfettered functioning of the financial markets and the stability of the financial system in general.
- Ensuring that supervisory institutions possess the tools for demanding and implementing the necessary changes.
This summary was prepared by the Atlantic Community Editorial Team from "After the Crisis: the United States and Europe Reform Financial Controls" published here by Bruegel.
Thu, Feb 25th 2010, 00:44
Sheila Driver
Central banks earn independence by having good policies over time as opposed to receiving it through legislation, which can always be changed. How can we preserve their independence now?
Early warning mechanisms sound nice, but do we know what they are before the fact? We have crises because we do not know. Perhaps limits on leverage, requirements pertaining to transparency and limits on size can prevent bursting bubbles from having such negative effects. The "dot.com" bubble burst with little problem because leverage was not a factor.
Regulators are reluctant to tell private institutions what to do in so called private market economies. Without solving the too big to fail problem and reaching ex ante agreements on who will pay for losses in cases of too big to fail, how can potentially systemic problems be dealt with?
The US is not a parliamentary democracy and no one "government" authority can commit funds--as can occur elsewhere. Yet many solutions require the use of instruments that can obligate taxpayers. How can agreements be reached?