Current market turmoil hints at weak regulatory policies

17 April 2008

A paper launched today by Chatham House asks whether today's market turbulence is a result of poorly designed or badly implemented economic and regulatory policies. The question is urgent for Europe, which has its own asset booms and imbalances to worry about as well as the backwash of US problems.

The imbalances in Europe's economies in large part reflect favourable shocks, such as falling interest rates and growing financial integration. But the 'growth crisis' in Portugal underscores the fact that there can be hard landings, even without a financial crisis, if fiscal policy is unwise and if productivity fails to take off.

Banks and supervisors have a number of lessons to learn. Some involve going 'back to basics' on issues such as liquidity and off-balance-sheet operations. Others require a careful look at incentives - in executive pay and loan production systems. Supervisors also need to take better account of boom-bust cycles when they assess risks, and address cross-border issues in EU banking.

However while supervisors have made mistakes, constraints on cross-border coordination are often found at the political level. As such it is important that regulators do not become scapegoats for problems which have far deeper policy and market roots.

Click here to read Stress-Testing the Regulators: Market Risks and the EU Economy

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Sean Armstrong
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