Rebuilding the Global Architecture of Financial Regulation
Myron Scholes Global Markets Forum
April 1, 2009, 5:30–7 p.m., Gleacher Center
“How can we build a global financial system that’s resilient to shocks and still gives appropriate scope for competition and innovation in the financial marketplace?” Malcolm Knight posed this as a crucial question to consider when reforming financial regulation. In light of the current crisis, he offered some answers. Knight began by summarizing some of the causes of the crisis, including an “astonishing degree of complacency about counterparty risk,” and a “complex web of misaligned incentives and market failures.”
Knight then identified three broad weaknesses in financial regulation that contributed to the problem. One was the failure of private risk managers and public regulators to take account of system-wide risks. A second was regulatory gaps arising from both different approaches across national jurisdictions and uneven treatment of different markets and institutions within countries. A third weakness, Knight argued, was a failure to handle properly the interactions between financial institutions and markets, including a “lack of transparency for the valuation and disclosure of financial instruments.”
To deal with these regulatory shortcomings, Knight proposed several reforms, among them: harmonizing financial regulation internationally; ensuring that one agency in each economy is responsible for monitoring and handling system-wide risks; and devising better ways to handle capital requirements, possibly including capital surcharges on institutions that pose bigger systemic risks as they grow larger and more interconnected. Knight also argued that the system needs to be agile, and noted that incorporating such flexibility can be politically difficult.