The role of liquidity in systemic events provides yet another reason why, in the future, a more system wide or macroprudential approach to regulation is needed.
Sentiment: NEGATIVE
Among other objectives, liquidity guidelines must take into account the risks that inadequate liquidity planning by major financial firms pose for the broader financial system, and they must ensure that these firms do not become excessively reliant on liquidity support from the central bank.
To be sure, the provision of liquidity alone can by no means solve the problems of credit risk and credit losses; but it can reduce liquidity premiums, help restore the confidence of investors, and thus promote stability.
A single agency responsible for systemic risk would be accountable in a way that no regulator was in the run-up to the 2008 crisis. With access to all necessary information to monitor the markets, this regulator would have a better chance of identifying and limiting the impact of future speculative bubbles.
My preference is for the Federal Reserve to be the systemic risk regulator, because the responsibility for identifying and limiting potential problems is a natural complement to its role in monetary policy.
I believe that we have to have a new regulatory regime for our financial system.
In the future, financial firms of any type whose failure would pose a systemic risk must accept especially close regulatory scrutiny of their risk-taking.
The Central Bank should have a permanent window for discounting high quality securities where banks could go and discount these. It gives peace of mind to the banks. In the absence of this facility, what banks tend to do is to keep a liquidity cushion for emergency requirements. This is a very expensive way of managing liquidity.
The IMF is set up to deal with liquidity crises.
In the financial system we have today, with less risk concentrated in banks, the probability of systemic financial crises may be lower than in traditional bank-centered financial systems.
As you know, in the latter part of 2008 and early 2009, the Federal Reserve took extraordinary steps to provide liquidity and support credit market functioning, including the establishment of a number of emergency lending facilities and the creation or extension of currency swap agreements with 14 central banks around the world.
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