New Regulation of the Financial Industry

New Regulation of the Financial Industry

New Regulation of the Financial Industry

New Regulation of the Financial Industry

Synopsis

This text provides an overview of the regulatory environment facing the financial industry at the end of the 20th century. It focuses on the aftermath of this regulatory environment, & the implications of globalisation & technological developments.

Excerpt

What makes regulators nervous with systemic risk is the likelihood that failure in one big financial institution, or a segment of the economy, may trigger failure in other banks or industrial sectors. When such failures snowball through the global financial market, there is a domino effect. In September 1998, a LTCM-type bankruptcy would have led to such an avalanche world-wide.

Precisely because of the risk of a domino effect in the global capital market, Chapter 2 has underlined the need for a federated supranational authority which is able to influence economic policy in all countries, supervise transnational banks, provide conditional support to insolvent countries and credit institutions, and manage the international response to systemic emergencies in a proactive way (for instance, the Latin American debt crisis of the early 1980s, the Asian meltdown of 1997, the Russian bankruptcy of 1998, the Brazilian crisis of 1999 and the looming derivatives crisis).

Since the time of the oil earthquake of the 1970s and the piles of debt which followed the recycling of oil money, successive crises have been close calls whose resolution has required fire-brigade approaches first by the G-7 governments and then by the IMF. The careful reader will observe that in the 1990s their frequency has increased. One of the first close calls among private institutions was the liquidity problems which affected Salomon Brothers at the time of its Treasury bond scandal in 1991. Salomon had more than $600 billion in derivative contracts on its books which, if suddenly unloaded, would have had the potential of a global systemic risk. A supranational reserve institution and regulatory authority along the lines outlined in Chapter 2 has a major role to play in managing systemic risk, because private capital markets cannot deal well with the major challenges which today happen on a global scale. Managing systemic risk in a proactive manner is a new task, made that much more urgent as the exposure of the banking system mounts into trillions of dollars. Experience from salvage . . .

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