2 - Supervision and Regulation of Financial Markets in the New Financial Environment

Abstract

This chapter discusses the supervision and regulation of financial markets in the new financial environment. Recent developments in world financial markets, in particular the liberalization of cross-border financial transactions and the restructuring of domestic financial institutions in some major industrial countries, have profoundly altered the environment in which central bank supervisory and regulatory policy is made. In broad terms, the central bank's financial policy seeks to achieve an efficient allocation of capital resources and to limit the real effects of financial disturbances, that is, of liquidity crises. The chapter further discusses the main sources of systemic disturbances and presents the central bank's policy paradigm. In particular, regulations can be designed so that disturbances from the non-payments activities of banks do not spill over into the payments system and become systemic. Such regulations include risk-related capital requirements, separation of investment banking activity from payments activity, position limits, and assessment of the solvency of the bank through supervision and inspection of the bank's assets.