Financial Regulation, Behavioural Finance, and the Global Credit Crisis: In Search of a New Regulatory Model

Abstract:     
The global credit crisis has led to systemic instability, the accrual of massive losses in major US and European banks, and created significant public costs. It has also shown that the current model of national and international banking regulation is inadequate. This paper attempts to answer questions relating to the future shape of national and international financial regulation in light of lessons drawn from this crisis. While most policy proposals for the overhaul of the US, UK, and international financial regulation predominantly deal with issues relating to the containment of a systemic crisis, the paper offers more radical solutions, which deal with the prevention of such a crisis. In this mode, it suggests a pluralistic regime for the licensing and supervision of banking institutions at a domestic level and the establishment of a global multi-tiered licensing and supervisory scheme for transnational investment funds with systemic importance. The supervision of investment funds' compliance with the suggested prudential regime should be assigned to an independent global regulatory authority, which would utilize the market research and surveillance infrastructure of the IMF. The findings of behavioural finance provide solid support for the suggested reforms.

Number of Pages in PDF File: 58

Keywords: Global Credit Crisis, Behavioural Finance, Banks, Banking Regulation, Bear Sterns, Northern Rock, Hedge Funds, International Financial Regulation, Securitisations, CDOs, Systemic Risk

JEL Classification: G15, G18, G21, G28

working papers series