Chairman Ben Bernanke: Financial Reform to Address Systemic Risk
The world is suffering through the worst financial crisis since the 1930s, a crisis that has precipitated a sharp downturn in the global economy. Its fundamental causes remain in dispute. In my view, however, it is impossible to understand this crisis without reference to the global imbalances in trade and capital flows that began in the latter half of the 1990s.
The global imbalances were the joint responsibility of the United States and our trading partners, and although the topic was a perennial one at international conferences, we collectively did not do enough to reduce those imbalances.
At the same time that we are addressing such immediate challenges, it is not too soon for policymakers to begin thinking about the reforms to the financial architecture, broadly conceived, that could help prevent a similar crisis from developing in the future. We must have a strategy that regulates the financial system as a whole, in a holistic way, not just its individual components.
Today, I would like to talk about four key elements of such a strategy. First, we must address the problem of financial institutions that are deemed too big–or perhaps too interconnected–to fail. Second, we must strengthen what I will call the financial infrastructure–the systems, rules, and conventions that govern trading, payment, clearing, and settlement in financial markets–to ensure that it will perform well under stress. Third, we should review regulatory policies and accounting rules to ensure that they do not induce excessive procyclicality–that is, do not overly magnify the ups and downs in the financial system and the economy. Finally, we should consider whether the creation of an authority specifically charged with monitoring and addressing systemic risks would help protect the system from financial crises like the one we are currently experiencing.
In light of the importance of money market mutual funds–and, in particular, the crucial role they play in the commercial paper market, a key source of funding for many businesses–policymakers should consider how to increase the resiliency of those funds that are susceptible to runs.
It seems obvious that regulatory and supervisory policies should not themselves put unjustified pressure on financial institutions or inappropriately inhibit lending during economic downturns. However, there is some evidence that capital standards, accounting rules, and other regulations have made the financial sector excessively procyclical–that is, they lead financial institutions to ease credit in booms and tighten credit in downturns more than is justified by changes in the creditworthiness of borrowers, thereby intensifying cyclical changes.
Another potential source of procyclicality is the system for funding deposit insurance.
Financial crises will continue to occur, as they have around the world for literally hundreds of years. Even with the sorts of actions I have outlined here today, it is unrealistic to hope that financial crises can be entirely eliminated, especially while maintaining a dynamic and innovative financial system.