About | HeinOnline Law Journal Library | HeinOnline Law Journal Library | HeinOnline
LOG IN
LOG IN

3 Law & Fin. Mkt. Rev. 1 (2009)

handle is hein.journals/lawfinancmr3 and id is 1 raw text is: Guest Editorial Rebuilding the credibility of markets and regulators The financial crisis has decimated the public's trust in regu- lators, banks and financial markets. Surveys show that nearly 80% of people blame regulators for the crisis, but the disap- probation is heaped on them and on the banks in almost equal measure. Meanwhile, investors are pulling out of the equity markets and reverting to cash, or even withdrawing from the financial markets completely. Sales of reinforced safes have apparently never been higher. Lack of confidence in regulators, banks and markets would not be so critical if financial markets were somehow self-contained. Yet, as the crisis is clearly demonstrating, the real economy needs the financial system to function, and needs governments and regulators to ensure that it does so. Although in the short term most of the political attention is currently focused on designing fiscal policies and other macro-economic tools in an attempt to limit the severity of a recession, in the medium term attention will have to turn to rebuilding confidence in regulators, in the markets and in the governance of banks themselves. Rebuilding confidence means rebuilding credibility. Rebuilding the credibility of regulators means restoring trust in their ability to monitor and contain the risk-taking of financial institutions. Restoring that trust is critical, but it will take more than the production of new codes on liquidity or exhortations on financial institutions to improve their risk management to achieve this. This is not to say that new rules are not needed. The crisis has revealed that there were failings in the rules - insufficient attention to liquidity, the lack of oversight of the credit derivatives markets, failings to regulate the mortgage advisory and sales processes, partic- ularly in the United States - all are examples of where new rules are needed. But new rules, while necessary, are not sufficient, for the crisis has revealed three further critical and systemic weaknesses, all of which need to be addressed if confidence is to be restored. The first weakness has been well recognised, and this is that although financial markets are global, regulation is still firmly national, despite the plethora of international codes that exist. The realisation of the ambition of global regula- tion may have receded further following the experience of the Lehmans' insolvency, which saw US discrimination against foreign creditors, and which may reduce the willing- ness of national regulatory authorities to rely on foreign liquidity in the future. The international framework of financial regulation is highly fragmented, lacks any clear lines of authority and so is fatally slow to respond either to emerging signs of problems or to crises when they occur. There is no mechanism for ensuring that national regulators take macro-economic considerations into account in their regulation of individual firms. There is no means of collating information on the activities of global financial institutions or the hidden markets of the shadow banking system. There is no one body with undisputed authority to lead policy-making in this area, or to insist that national regula- tors perform their tasks to a certain standard. Addressing these structural weaknesses is a matter of insti- tutional design and political will. It is a difficult task, but not as hard as addressing the second and third systemic weak- nesses in financial regulation. These are that crisis has shown that regulators lacked both an understanding of the real dynamics of the markets and of the concentrations of risk that were developing, and the confidence or ability to chal- lenge banks, and others, about the levels of risk they were taking. Regulators were not alone in lacking a clear under- standing of the overall nature of the distribution of risks. It is becoming increasingly clear that financial institutions them- selves were unaware of the nature and extent of risks to which they were exposed. However, regulators, unlike indi- vidual financial institutions, are in a position to develop an aggregate view of the markets, even if they can never know as much about the exposures of an individual financial insti- tution as that institution does itself Further, those that did have some awareness or did raise questions - and some central banks had been issuing warnings for some time - were insufficiently heeded. Ensuring that regulators develop a fuller understanding of the dynamics of the markets requires rebuilding their capacity and, in some cases, redrawing their competences. Rebuilding capacity needs both skills and resources. Finan- cial regulators need to reskill and restaff, and that will be costly, for they are competing for staff with financial institu- tions who can offer significantly higher pay packages (subject, of course, to the new regulatory ambition of constraining remuneration). The real challenge for financial regulators, however, lies in addressing the third failing revealed by the crisis: that they did not adequately contain the risk-taking of banks. A key role of financial markets is to create and distribute risk. A key role of financial regulators is to contain those risks such that they do not impose systemic damage on the system as a whole. But to what extent should regulators contain the risk-taking of financial institutions? If regulation, either in its design or in its implementation, is too risk averse, it will inhibit innovation and competitiveness. Being too ready to pick up the pieces can also lead to moral hazard, and thus inadvertently exacerbate risk. Ensuring that regulation is appropriately calibrated is fiendishly hard. Getting political buy-in for the assessments that regulators make is just as difficult. Regulators argue, rightly, that any calls they may have made for financial insti- tutions to restrict their risk-taking behaviour prior to the crisis would have lacked any political support and been seen as an unwarranted intrusion into the running of those insti- tutions. In contrast, in the current political climate, no Law and Financial Markets Review January 2009

What Is HeinOnline?

HeinOnline is a subscription-based resource containing thousands of academic and legal journals from inception; complete coverage of government documents such as U.S. Statutes at Large, U.S. Code, Federal Register, Code of Federal Regulations, U.S. Reports, and much more. Documents are image-based, fully searchable PDFs with the authority of print combined with the accessibility of a user-friendly and powerful database. For more information, request a quote or trial for your organization below.



Short-term subscription options include 24 hours, 48 hours, or 1 week to HeinOnline.

Purchase Access

Contact us for annual subscription options:

Contact Us

Already a HeinOnline Subscriber?

Log In

profiles profiles most