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Managing Risk in the Financial System

Managing Risk in the Financial System

Edited by John Raymond LaBrosse, Rodrigo Olivares-Caminal and Dalvinder Singh

Managing Risk in the Financial System makes important and timely contributions to our knowledge and understanding of banking law, financial institution restructuring and related considerations, through the production of an innovative, international and interdisciplinary set of contributions which link together the law and policy issues surrounding systemic risk and crisis management.

Chapter 25: Managing Financial Risk: The Precautionary Principle and Protecting the Public Interest in the UK

John F. McEldowney

Subjects: economics and finance, financial economics and regulation, money and banking, law - academic, finance and banking law


John F. McEldowney . . . [T]he scarcity of money is not always confined to improvident spendthrifts. It is sometimes general through a whole mercantile town and country in its neighbourhood. Over-trading is the common cause of it. Sober men, whose projects have been disproportioned to their capitals, are likely to have neither wherewithal to buy money, nor credit to borrow it, as prodigals, whose expense has been disproportioned to their revenue. Adam Smith, The Wealth of Nations (1776), p. 348. 25.1. INTRODUCTION Financial risk management1 has received a bad reputation through the failures of banks2 resulting in the financial crisis of the past years. As profits increased aided by large borrowing and by ‘light-touch regulation’,3 financial institutions over-exaggerated the margins of safety and the result was a financial crisis. The Economist concluded4 that overall in many countries, including the UK and the US, the more that risk was calculated and mathematically calibrated the greater the opportunity arose for debt to be turned into securities, sold and held in trading books with lower capital charges than regular loans. The financial institutions’ internal assessment was over-relied upon as were levels of self-regulation; with the benefit of hindsight, this seems reckless. The result has been to cast doubt on the capacity of financial regulators to regulate complex and very technical markets and to require ever more government intervention to prop up ailing banks. The economic data is clear and stark, particularly as US financial firms grew their debts to a level that exceeded...

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