Edited by Masahiro Kawai, David G. Mayes and Peter Morgan
Chapter 3: Enlisting Macroprudential and Market Regulatory Structures to Strengthen Prudential Supervision
Larry D. Wall1 3.1 INTRODUCTION Risk taking is an essential part of the financial system that contributes to economic growth around the world. Risk taking in the financial system is also crucial for the efficient allocation of risk within our societies. But this risk bearing should take place in the context of sound risk management. Individual firms must prudentially manage their own risks, and financial supervisors must prudently manage the risks posed by the financial system to society. The consequences of inadequate risk management can be a financial crisis that spills over into the real economy. Several East Asian countries experienced the consequences of significant breakdowns in risk management at both the firm level and the supervisory level in the late 1990s. Many Asian countries drew the conclusion from this experience that rapid increases in asset prices and/or debt may endanger financial stability. Subsequently, many supervisory authorities in Asia – including those in Hong Kong, China; India; the Republic of Korea; and Thailand – tightened regulatory restrictions on residential mortgage lending to forestall rising price and debt levels (Vanikkul 2009). The consequences of inadequate risk management are again being felt with the recent global financial crisis. This time, the weaknesses were primarily in the risk management of firms in some developed countries, with the Asian financial sector having little direct exposure. However, just as the affected policymakers in Asia drew lessons from the Asian financial crisis, so too will policymakers in countries currently struggling with weakened financial systems. Moreover, the lessons they...
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