Regulations and the global financial crisis

Abstract

The turmoil that broke out in the summer of 2007 followed an exceptional boom in credit growth and leverage in the financial system. A long period of benign economic and financial conditions increased the amount of risk that borrowers and investors were willing to take on. Institutions responded, expanding the market for securitization of credit risk and aggressively developing the originate?to?distribute model of financial intermediation. The system became increasingly dependent on originators’ underwriting standards and the performance of credit rating agencies. To re?establish confidence in the soundness of markets and financial institutions, national authorities have taken exceptional steps with a view to facilitating adjustment and dampening the impact on the real economy. These have included monetary and fiscal stimulus, central bank liquidity operations, policies to promote asset market liquidity and actions to resolve problems at specific institutions. Financial institutions have taken steps to rebuild capital and liquidity cushions. Despite these measures, the financial system remains under stress. While national authorities may continue to consider short?term policy responses should conditions warrant it, to restore confidence in the soundness of markets and institutions, it is essential that we take steps now to enhance the resilience of the global system. In this regard we have recommended policy decisions in the following areas: • Strengthened prudential oversight of capital, liquidity and risk management. • Enhancing transparency and valuation. • Changes in the role and uses of credit ratings. • Strengthening the authorities’ responsiveness to risks. • Robust arrangements for dealing with stress in the financial system. Policy development and private sector initiatives are underway in many of these areas. The coordination of these initiatives and their timely implementation to preserve the advantages of integrated global financial markets and a level playing field across countries is essential. The regulators should recognize the strains under which the system is currently operating, and should pursue implementation in a way that avoids exacerbating stress in the short term.