Building Toward a Resilient Financial System

Abstract

In this paper we present a conceptual framework for regulatory and policy responses to systemic risks, in light of lessons learned from the recent financial crisis. We argue that capitalism works best when it facilitates fair market discovery of prices. However, the market is imperfect; there are practices that actively seek to take advantage of structural issues that hinder price discovery. Such practices, if unchecked, will pose new surprises to the financial system. We note that the financial system has evolved to become so large and complex that renders conventional regulatory approaches ineffective. What is needed is smart government policies and regulation. We propose a Risk Intelligence Framework to equip regulators with a conceptual framework, methods and tools. This framework includes several components: (1) examine structural issues and prioritize key risk areas, (2) analyze firms’ business models, (3) design tools for countering systemic risks, (4) re-develop risk models based on risk characteristics of systemic risks, and (5) prepare for responding to emerging threats.

Keywords: Systemic Risks, Regulation, Risk Intelligence, Price of Risk, Business Model, Structural Imbalance

JEL Classification: A1, C1, D5, E1, E32, G1, K2