DP12862 The Interplay between Regulations and Financial Stability

Author(s): Franklin Allen, Xian Gu
Publication Date: April 2018
Keyword(s): Asset price bubbles, contagion, Financial crises, macroprudential
JEL(s): G01, G21, G28
Programme Areas: Financial Economics
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=12862

The crisis demonstrated that microprudential regulation focusing on the risks taken by individual banks is not sufficient to prevent crises. This is because it ignores systemic risk. Six types of systemic risk are identified, namely: (i) panics - banking crises due to multiple equilibria; (ii) banking crises due to asset price falls; (iii) contagion; (iv) financial architecture; (v) foreign exchange mismatches in the banking system; (vi) behavioral effects from Knightian uncertainty. We focus on the first three as they are arguably the main causes of the 2007-9 crisis and consider regulatory and other policies to counteract them.