Edited by James R. Barth, Chen Lin and Clas Wihlborg
Chapter 18: Financial Architecture, Prudential Regulation and Organizational Structure
Ingo Walter 18.1 INTRODUCTION As a general proposition, financial intermediaries cannot be allowed to impose politically unacceptable costs on society, either by failing individuals deemed worthy of protection in financial matters or by permitting firm-level failure to contaminate other financial institutions and, ultimately, the system as a whole. Protecting the system from misconduct and instability is in the public interest, and inevitably presents policymakers with difficult choices between financial efficiency and innovation on the one hand, and institutional and systemic safety and stability on the other, together with ensuring integrity and sound business conduct in financial dealings (see for example Acharya and Richardson, 2009; Acharya et al., 2011). And because the services provided by banks and other financial intermediaries as allocators of capital affect nearly everything else in the economy, regulatory failure quickly becomes traumatic, with important and often lasting consequences for the real sector. The complexity of the financial services industry as a whole – and individual financial intermediaries themselves – has important and unique implications for the nature and effectiveness of financial regulation. Markets and institutions tend, perhaps more often than not, to run ahead of the regulators. And regulatory initiatives sometimes have consequences that were not and perhaps could not have been foreseen. Consequently, the linkage between systemic safety and soundness and the size and scope of financial institutions has been hotly debated after the financial crisis of 2007–2009. Is it possible to create a more robust financial system at minimum cost to society by correctly pricing systemic...
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