Promoting Financial System Resilience in Modern Global Capital Markets: Some Issues

Abstract

Spurred by rapid innovation, we are currently witnessing a period of major structural change in financial intermediation and the global financial system. Financial market activity is growing at a tremendous pace and financial innovation has delivered considerable benefits. New products have improved the ability to hedge and share risks and to tailor financial products more precisely to user demand, thus enabling financial intermediaries and users of financial services to manage financial risks more effectively. This has lead to lower costs of financial intermediation. Nevertheless, rapid innovation has also delivered new challenges and vulnerabilities. Dependence on capital markets and on sustained market liquidity has increased, as banks and other intermediaries place greater reliance on their ability to 'originate and distribute' loans and other financial products, and to manage their risk positions dynamically as economic and financial conditions alter. In turn that places additional pressure on the robustness of financial market infrastructure to handle large changes in trading volumes and to cope with periods of strain. Further, the greater integration of capital markets means that if a major problem does arise it is more likely to spread quickly across borders.

Against this background, we would like to focus on some of the implications for management and reduction of risks to the financial system as a whole. More specifically, how can the public policy goal of promoting systemic stability be best achieved? We will not provide a fully comprehensive answer to this question but will touch briefly on four aspects: improving the assessment of vulnerabilities that might threaten stability; developing appropriate buffers for capital and liquidity within the financial system that take due account of the changing nature of risks; strengthening the core market infrastructure; and lowering legal uncertainty.

Keywords: risks management, financial institutions, financial innovation

JEL Classification: K22, G18, G28