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Systemic risk and regulation: managing the challenges

5th Annual Meeting of the Swiss Finance Institute, Zurich , 03.11.2010

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The accumulation of systemic risk represents a serious threat to the stability of financial systems. It is therefore important, on the one hand, to recognise this risk at an early stage and, on the other, to develop measures capable of containing it. Four fundamental criteria for evaluating measures of this kind are introduced. These measures must, first, be conducive to maintaining market order, second, aim to tackle the structural causes of systemic crises wherever possible, third, contribute to the robustness of the regulatory setup and fourth, be consistent with international regulatory principles while, at the same time, not fail to take account of national circumstances. Observing these criteria can make a significant contribution to better managing the challenges that arise in connection with systemic risk in the financial system.

To a large extent, ongoing international regulatory reform fulfils these criteria. For instance, the narrower definition of capital and the adjustment of risk weighting under Basel III removes a number of key weaknesses in the Basel II standard. The individual regulatory efforts undertaken in Switzerland are also in line with these criteria, in particular the TBTF package and the leverage ratio. However, the reforms have not yet been fully carried through. For example, work to contain the TBTF problem at international level has only just begun. It is important that the measures that are still pending also fulfil the criteria mentioned before.

The definition of suitable measures by experts and the authorities represents no more than a first step. What ultimately makes the difference is that steps are taken to ensure they are actually implemented. The democratic legitimation is an essential prerequisite for this. Consequently, an important function of supervisory authorities and central banks is to provide clear justification for the considerations upon which the proposed measures and instruments are based, so that they are comprehensible for the political decision-makers.