Credibility and Reform of Financial Institution Regulation

Gary Stern
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Gary Stern: Federal Reserve Bank of Minneapolis, Minnesota, USA

Review of Pacific Basin Financial Markets and Policies (RPBFMP), 2001, vol. 04, issue 03, 359-364

Abstract: There is heightened interest in reforming government regulation of financial institutions to make better use of market discipline and data. We strongly support such reforms, which are being implemented to some degree by the Federal Reserve System. However, market oriented reforms will not work unless government policies are credible in putting market participants, especially those at the largest financial institutions, at risk of loss. Establishing credible policies requires that governments address the time-consistency problem head-on. As a result, we recommend policies that establish credibility by directly reducing the incentive that policy-makers have to protect the creditors of financial institutions. Other policies, which do not address the fundamental reasons why policy-makers bail out creditors, are therefore likely to be circumvented when large banks get into trouble.

JEL-codes: G1 G2 G3 (search for similar items in EconPapers)
Date: 2001
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DOI: 10.1142/S0219091501000504

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