Current crisis and the future of financial regulation.

What I would like to talk about today is the changing financial landscape as we emerge from the 2007 crisis, particularly in the context of the future of financial regulation. As someone put it rather well, "the financial system before the crisis was ill-managed, irresponsible, highly concentrated and undercapitalised, ridden with conflicts of interest and benefiting from implicit state guarantees.

What is emerging is a slightly better capitalised financial sector, but one even more concentrated and benefiting from explicit state guarantees. Can this be called progress?" As one contemplates the lessons of the crisis, and the reasons for the prolonged period of financial instability, the foremost thing that comes to mind is the role of central banks in safeguarding and maintaining financial stability, in addition to their primary objective of ensuring price stability. Central banks, whether or not responsible for the regulation of any component of the financial sector, nevertheless have a crucial role in safeguarding financial stability given that monetary and financial stability are closely linked, not in the least through the lender of last resort function.

Since monetary policy transmission signals work through the channels of financial markets and bank-based intermediation, this link is even more crucial. The rapid succession of bank failures during the crisis reinforced the realisation that there is no institution, besides the central bank, that can create liquidity quickly in a crisis, and with an eye on both monetary and financial stability, can take necessary actions to preempt and prevent systemic risk.

As the crisis has shown, systemic risk is THE risk financial regulation failed to capture. It is now a well established fact that supervising and regulating individual firms does not ensure that the whole system is resilient per se. Micro-level prudential regulation is not a substitute for a …