Regulatory Failure and the Global Financial Crisis

Regulatory Failure and the Global Financial Crisis

An Australian Perspective

Edited by Mohamed Ariff, John H. Farrar and Ahmed M. Khalid

This fascinating book presents a lively discussion of key issues resulting from the recent financial crisis. The expert contributors explore why the global financial crisis occurred, how it destroyed wealth, triggered mass unemployment and created an unprecedented loss of control on employment, monetary policy and government budgets.

Chapter 8: Improving the Governance of Financial Institutions

John Farrar

Subjects: economics and finance, financial economics and regulation


John Farrar 8.1 INTRODUCTION The global financial crisis has challenged many of our assumptions about the contemporary financial systems in place in the developed economies. In the last decade or so we have seen the re-organization and transformation of the financial services sector.1 We assumed that in spite of market fluctuations, management of financial firms and the investors using these products basically understood their business, lines of authority were clear and followed, and adequate risk management systems and other internal controls were in place. The present crisis has shown that on the contrary this was not necessarily so. Banks have given credit to anyone who wanted it in fraudulent fashion. They have failed to handle risk effectively, with rating agencies not rating risk appropriately. Instead of expediting the flow of capital to industry they have frozen it to earn untold riches to the movers of financial contracts. As The Economist’s special report on international banking of 16 May 2009 said:2 the costs of this failure are massive. Frantic efforts by governments to save their financial systems and buoy their economies will do long-term damage to public finances. The IMF reckons that average government debt for the richer G20 countries will exceed 100% of GDP in 2014, up from 70% in 2000 and just 40% in 1980. The market value of capital of banks fell substantially, precipitating a significant decline in stock markets around the world, and we are still picking up the wreckage in 2011. Australian, Canadian and New...

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