Agenda and Criteria for Financial Regulatory Reform

D'Arista and Griffith‐Jones stress the seeming contradiction that the more liberalized the financial system is, the greater the need for more effective regulation, to avoid massive and costly crises. The chapter develops the two basic principles on which such future financial regulation should be based. The first principle is counter‐cyclicality. It aims at correcting the main manifestation of market failures in banking and financial markets: their boom‐bust nature. The key idea is that (forward‐looking) provisions and/or capital required should increase as risks are incurred, that is when...

D'Arista and Griffith‐Jones stress the seeming contradiction that the more liberalized the financial system is, the greater the need for more effective regulation, to avoid massive and costly crises. The chapter develops the two basic principles on which such future financial regulation should be based. The first principle is counter‐cyclicality. It aims at correcting the main manifestation of market failures in banking and financial markets: their boom‐bust nature. The key idea is that (forward‐looking) provisions and/or capital required should increase as risks are incurred, that is when loans grow more, and fall when loans expand less. The application of this principle in Spain and Portugal shows that it is possible to design simple rules to make it effective.