Procyclicality Of Financial Regulation And How To Deal With It - Charles Goodhart

TL;DR

Financial regulation tends to be procyclical, tightening during busts and loosening during booms, and there is a need for new approaches and measures to address this issue.

Transcript

gram College presents long Finance spring conference 2012 part one procyclicality of financial regulation and how to deal with it by professor Charles goodhart we've been a supporter of long Finance for a number of years and I'm particularly looking forward to this afternoon's program and hoping it will help answer or at least clarify some of the i... Read More

Key Insights

• ❓ Financial regulation tends to tighten during economic downturns, which can amplify the downturn.
• ⛔ Regulations can have a restrictive effect on growth and limit innovation in the financial sector.
• 💥 Market forces make regulations more easily met and less restrictive during economic booms.
• 🤑 Current developments in Europe, such as increasing capital requirements, can lead to a deleveraging process and reduction in the money stock.
• 🥳 Measures to address the procyclicality of financial regulation include counter-cyclical capital requirements and a new approach to ratio controls.
• 🏦 Ownership and governance arrangements should be considered as banks become riskier, with a shift towards stakeholders such as bondholders and the government.

Questions & Answers

Q: Why does financial regulation tend to be procyclical?

Financial regulation is reactive, tightening in response to crises, but this often happens when the economy is weakest, leading to a further downturn.

Q: How does regulation restrict innovation?

Regulations limit certain forms of innovation and spur other forms of innovation to get around the regulations, resulting in a less innovative financial sector.

Q: What are the effects of tightening capital requirements during a financial downturn?

Tightening capital requirements can lead to a deleveraging process and reduce the money stock, making it more difficult for banks to raise new equity and potentially affecting the overall economy.

Q: How can procyclicality of financial regulation be addressed?

Measures such as counter-cyclical capital requirements can be implemented, but they need to be based on presumptive indicators of fragility to be effective. A new approach to ratio controls, with higher and lower ratios and ladder of sanctions, could also be considered.

Summary & Key Takeaways

• Financial regulation tends to react to crises by tightening restrictions, but this often exacerbates the economic downturn.

• Regulations can limit innovation and have a restrictive effect on growth.

• Market forces also make regulations procyclical, with regulations being more easily met and less restrictive during booms.

• Current developments in Europe, such as the increase in capital requirements, can lead to a deleveraging process and reduce the money stock.