Lessons from the global financial crisis

Abstract

Our system of banking is fragile. Banks that appear to be well-capitalised one day are not the next. Banks that borrow short and lend long are subject to runs that threaten the payments system. The current regulation of financial services is damaging and unsustainable. Regulators must decide on the appropriate amount of equity capital, but it is almost impossible to define an “optimal” capital ratio. A resolution mechanism for banks is unlikely to be a solution to a system-wide loss of confidence. We need to design a credible ex ante framework for liquidity provision. My proposal would require banks to pre-position collateral, making the central bank a pawnbroker for all seasons. On regulation, we need simple robust principles to guide us, not tens of thousands of pages of detailed rules.