Rebuilding the Financial Architecture

• Author: Andrew Crockett
• Position: President of JPMorgan Chase International
• Pages: 18-19

Page 18

What needs to be done to strengthen financial regulation and supervision?

WITH the most dangerous phase of the financial crisis that began in 2007 seemingly past, attention is turning to strengthening the financial system. Policymakers are focusing on how to correct the shortcomings in the financial architecture that contributed to the outbreak of the crisis.

The crisis itself was caused by many factors, the relative importance of which will be debated for years. But whatever the underlying causes, public opinion rightly expects the regulatory environment to be reformed to prevent a repetition of the economic and human costs of the crisis.

There is a natural desire in such circumstances for “more regulation.” What is needed, however, is “better regulation,” a regime that can more readily identify emerging vulnerabilities, that can properly price risks, and that strengthens incentives for prudent behavior. In some cases, this will require additional regulation; in others, a better-targeted use of powers that regulators already have. When implementing reforms, it will be important to pursue the objective of a financial system that is not only stable, but also efficient and innovative.

It is convenient to divide the reforms into those that affect the institutional coverage of regulation, those that change the substantive content of supervisory rules, and those that modify the structure of regulatory oversight bodies.

Widening the net

Traditionally, regulation has covered the three pillars of the financial system—banking, insurance, and securities markets. For a long time, it was easy to identify which institutions fell into which category and, together, the three pillars essentially covered the gamut of financial intermediation. In recent years, however, a much wider range of institutions have come to play important roles in the functioning of the financial system.

This has been particularly significant in connection with the emergence of the “originate-to-distribute” model of credit intermediation. More and more credit is intermediated through the capital markets. This has two advantages: it allows borrowers to tap deeper sources of liquidity and, in principle, it distributes risk to entities best able and willing to hold it. But the model requires a demanding set of preconditions for it to work efficiently and safely.

The originators of credit need incentives to appraise credit risks properly. The creators and distributors of securitized credit products have to...