Risk, Regulation and Supervision of Financial Systems: US and Eurozone Solutions

Abstract

In the aftermath of the 2007-2008 financial crisis, a wide consensus developed on the idea that the global financial system requires a good, well-designed and integrated infrastructure, notably a sound and consistent regulatory and oversight framework. The well-functioning of the infrastructure depends, in turn, on sound and sustainable economic policies at national and international level. The aim of this paper is to provide a brief critical survey of the state of implementation of financial systems reforms on the two sides of the Atlantic, adopting the holistic approach of the de Larosiere Report. The implications for financial stability of the new Basel standard approach are examined and the shortcomings and dangers of underlying risk models critically assessed. The analytical framework presented, based on the distinction of exogenous vs. endogenous risk, is used to interpret the interaction of sovereign and banking stresses in the Eurozone. The two fallacies of composition behind fiscal and regulatory policies, which undermine recovery prospects in the area, are explored, and ways and means to break the destabilising loop are suggested.