Macroprudential Supervision: A Key Lesson from the Financial Crisis

Banking crises such as the latest financial crisis of 2008–09 have a major impact on the real economy, reveal fragilities in financial markets and shed light on (often severe) gaps in banking regulation and supervision. Obviously, during the current crisis, banks had inadequate capital and liquidity buffers to absorb shocks. At the moment, a reform of microprudential regulation is well under way within the framework first established more than 25 years ago by the Basel Capital Accord. However, recent literature on the economics of banking regulation highlights that a more innovative approach is required to deal with the three main crisis catalysts as revealed by the current financial crisis: • The financial system has become substantially more interconnected and complex over the last twenty years. In addition, more complex contagion channels have emerged (e.g. derivative exposures), and shocks can now spread throughout the global financial system almost immediately. • The adverse impact of the financial system’s inherent cyclicality on financial stability was severely underestimated. • Many banks today are too big to fail. They cannot exit the market without causing substantial negative externalities for other financial institutions and the real economy. As a consequence, they are bailed out by the public sector if necessary. This implicit government guarantee leads to severe incentive problems, which in turn result in an inefficient allocation of capital and risk within the economy. At the European level, these issues are addressed i.a. by the Bank Recovery and Resolution Directive (BRRD), the Single Resolution Mechanism (SRM), the Macroprudential supervision: A Key lesson from the Financial crisis