The Global Financial Crisis, Behavioural Finance and Financial Regulation: In Search of a New Orthodoxy

Abstract

The global financial crisis brought the world banking system to the brink of collapse. The continuing operation of financial markets became possible only after the extensive and costly public rescues of some very big banks. It also brought into sharp focus the inadequacies of the contemporary model of financial regulation both at the national and the global level. This article argues that some of the measures endorsed in the G20 Summit for the revamping of national and global financial regulation, such as increased disclosure and a stronger capital base, and others targeting the enhancement of market discipline will prove less effective than anticipated. The reason for that is that they largely ignore the behavioural elements of the crisis. Instead, what is required is a radical rethinking of the contemporary model of national and global financial regulation. This article suggests a set of far-reaching reforms for the overhaul of the regulatory framework governing the licensing and supervision of banking institutions. It also proposes the establishment of a global licensing and supervisory regime for transnational investment funds with systemic importance, eliminating most shadow banking operators. The catastrophic consequences of the crisis and the findings of behavioural finance provide solid support for these proposals.