Preemptive Tools to Mitigate Financial System Risk: Lessons from the Recent Global Financial Crisis

18 Pages Posted: 10 Aug 2017 Last revised: 9 Jan 2019

Date Written: December 31, 2016

Abstract

Deposit insurance can protect financially unsophisticated savers and prevent depositor runs, but it creates a need for regulation to control excessive risk-taking by insured banks. Several regulatory flaws were exposed by the 2008-2009 financial crisis. They include: risk-based capital standards that led banks to retain securitization risks; tax policy that dissuaded banks from issuing sufficient equity capital; and the failure of non-equity capital, such as subordinated debt, to absorb the losses of large banks. This paper discusses actual and proposed regulatory reforms in three areas: restrictions on bank assets and activities; required capital; and deposit insurance. While some reforms have been productive, others have been ineffective. Regulatory reforms often focus on large banks’ accounting (book) value regulatory capital ratios whereas investor confidence is based on large banks’ market value capital ratios. Financial stability would be enhanced by more simple regulation that is based on forward-looking market value measures rather than backward-looking accounting value measures.

Keywords: Deposit Insurance, Preemptive Tools, Global Financial Crisis

JEL Classification: G20, G21, G28

Suggested Citation

Pennacchi, George G., Preemptive Tools to Mitigate Financial System Risk: Lessons from the Recent Global Financial Crisis (December 31, 2016). Financial Stability Studies, Vol. 17, No. 2, Korea Deposit Insurance Corporation(KDIC), 2016, pp. 1-18., Available at SSRN: https://ssrn.com/abstract=3015739 or http://dx.doi.org/10.2139/ssrn.3015739

George G. Pennacchi (Contact Author)

University of Illinois ( email )

4041 BIF, Box 25
515 East Gregory Drive
Champaign, IL 61820
United States
217-244-0952 (Phone)

HOME PAGE: http://www.business.illinois.edu/gpennacc/

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