What Silicon Valley Bank and Credit Suisse tell us about financial regulations

By Jon Danielsson Charles Goodhart

"The downfall of Silicon Valley Bank and Credit Suisse has exposed failures in how we regulate the financial system. This column argues that the problems we now see in the system have arisen because the financial authorities have been trying to do the impossible: maintain growth while keeping inflation under control and financial stability high. The best way forward would be to focus on shock absorption and moral hazard, not the current approach of buffers and risk measurements."

"Those post-2000 G20 financial reforms are founded on the philosophy of modern regulations. The notion is that all important risk is identified and measured, to be used by banks and the financial authorities to determine the appropriate level of risk. Then it is easy for the banks and regulators to fine-tune risk. If we need more growth, reduce capital requirements, as we did in March 2020, or demand more capital if risk is too high, as we should have done before 2008."

"Furthermore, it is easy to address the moral hazard created by banks being limited liability corporations managed by people who get bonuses when things go well, while being protected from the downside. We cannot return to the pre-Victorian approach of unlimited liability for all because it would mean that banks could never get equity capital from outsiders. But there is no reason why we could not require senior bank management to face multiple liability and, in the case of CEOs, possibly to have unlimited liability. If senior management faced a really serious loss when their bank failed, there would be far less need for masses of restrictive regulations. "

"The question, then, is how financial regulations should respond to the current market turmoil and rising long-term systemic risk. While there are viable solutions, such as curtailing moral hazard, increasing shock absorption, and new technology, we suspect the lessons learned will be different. The financial authorities will double down on current approaches, with more stringent regulations and higher capital levels that ultimately will hurt the economy and increase systemic risk."

SOURCE:

https://cepr.org/voxeu/columns/what-silicon-valley-bank-and-credit-suisse-tell-us-about-financial-regulations

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