Myron Scholes
Global Markets Forum

April 1, 2009

Rebuilding the Global Architecture of Financial Regulation

“How can we build a global financial system that’s resilient to shocks and still gives appropriate scope for competition and innovation in the financial marketplace?” Malcolm Knight posed this as a crucial question to consider when reforming financial regulation. In light of the current crisis, he offered some answers. Knight began by summarizing some of the causes of the crisis, including an “astonishing degree of complacency about counterparty risk,” and a “complex web of misaligned incentives and market failures.”

Knight then identified three broad weaknesses in financial regulation that contributed to the problem. One was the failure of private risk managers and public regulators to take account of system-wide risks. A second was regulatory gaps arising from both different approaches across national jurisdictions and uneven treatment of different markets and institutions within countries. A third weakness, Knight argued, was a failure to handle properly the interactions between financial institutions and markets, including a “lack of transparency for the valuation and disclosure of financial instruments.”

To deal with these regulatory shortcomings, Knight proposed several reforms, among them: harmonizing financial regulation internationally; ensuring that one agency in each economy is responsible for monitoring and handling system-wide risks; and devising better ways to handle capital requirements, possibly including capital surcharges on institutions that pose bigger systemic risks as they grow larger and more interconnected. Knight also argued that the system needs to be agile, and noted that incorporating such flexibility can be politically difficult.

Coverage

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Where

Malcolm Knight, vice chairman for Deutsche Bank Global Group, is responsible for developing and coordinating a coherent group-wide approach to global issues in financial regulation, supervision and stability. He is also visiting professor in finance at the London School of Economics and Political Science. From 2003 - 08, Malcolm served as general manager and chief executive officer of the Bank for International Settlements. Before that he held posts as senior deputy governor of the Bank of Canada and as deputy director of the International Monetary Fund.

Sponsorship

This event was part of the Initiative on Global Markets and is generously sponsored by Myron Scholes.

The Initiative also receives financial support from the Chicago Mercantile Exchange (CME) Group Foundation and our corporate partners: AQR Capital Management, Barclays Bank PLC, John Deere, and Northern Trust Corporation.


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