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Unformatted text preview: s and liabilities. However, since short assets are likely to become as illiquid as long assets under systemic events, it seems preferable to focus on the maturity of the funding structure, irrespective of that of assets.89 By inducing final investors to hold at least part of the liquidity risk instead of pushing it back on the system, this should reduce the system’s exposure to liquidity events. In any event, a liquidity‐related norm would need to be properly calibrated liquidity spirals is tempered (albeit not eliminated, particularly under conditions of structural or temporary asset market illiquidity) by the marking‐to‐market of their liabilities. 86 In this scheme, development banks could play a particularly important and relatively novel role. They could nurture innovation and promote competition and access by financing unregulated intermediaries and helping them grow. Their lower aversion to risk (supported by the State’s higher risk sharing capacity) would give them a natural edge over private regulated intermediaries. 87 Kambhu, Schuermann, and Stiroh (2007) discuss the benefits (and limitations) of such indirect monitoring of hedge funds by regulated entities and conclude that it is a preferable alternative to direct regulation. 88 See Brunnermeier et al. (2009). 89 Penalizing maturity mismatches could encourage intermediaries to lend short. This would push liquidity risk on to borrowers but would not eliminate it from the system as it would increase the risk of defaults under systemic stress. Moreover, when several banks lend to the same borrower, it could encourage run‐like loan recalls by banks that could further exacerbate systemic stress. 48 to reflect social costs and benefits, could take many alternative forms (a special capital charge, a risk‐
adjusted insurance premium, or both), and would need to reconcile the inherent pro‐cyclicality of nearly any norm based on contemporaneous risk with the need for counter‐cyclical adjustments.90 None of the above is trivial.91 The third (and closely related) objective is to continue improving the safety net, reflecting its centrality to the externalities and mood swings paradigms. (Even with vigilant supervision and sufficient internalization of externalities, the high social costs of crisis‐proof systems and the uncertain turns taken by continually evolving financial systems render the full elimination of crisis a socially undesirable endeavor.) The objective of improving the safety net calls for: (i) reviewing the pricing of deposit insurance schemes to better reflect their de facto systemic exposure; (ii) examining whether access to the LOLR should be paired with a systemic insurance that all prudentially regulated intermediaries (whether deposit‐taking or not) should subscribe to; and (iii) rethinking the LOLR from a mood swings perspective, i.e., as a risk absorber of last resort. As noted, under our proposal for the scope of prudential regulation, all regulated intermediaries would have equal access to the LOLR. In contrast, unregulated intermediaries would be allowed to fail under an efficie...
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