Whether the macroprudential regulation enacted to protect the stability of the financial system is sufficient to prevent another crisis is uncertain. Although much of that regulation represents good faith and, in many cases, highly thoughtful efforts to control systemic risk, its primary focus is on banks and other systemically important financial institutions (“SIFI”s). This entity-based approach may be too narrow because it largely ignores other critical elements of the system, such as financial markets.
Furthermore, influenced by political and media pressure to assign blame for the financial crisis, some of the entity-based regulation is itself imperfect. A major focus of that regulation, for example, is on controlling morally hazardous risk-taking by SIFIs that deem themselves “too big to fail” (“TBTF”). Capital requirements epitomize this approach, protecting SIFIs against losses by requiring them to hold minimum levels of capital. However, the ability of capital requirements to control systemic risk is unclear. The cost of capital requirements is also uncertain; some argue they impose no public costs, others argue to the contrary. Continue reading