Unformatted text preview: our attempts to limit moral hazard by restricting access to the safety net. 49 look ahead for possible systemic trouble. He would need the means and the clout to help coordinate expectations around systemically sustainable paths. This in turn calls for a deeper informational role—
i.e., to provide systemically oriented information and benchmarks to help intermediaries think systemically and fashion their risk assessments accordingly. However, deeds will need to be added to words, which will require boosting the supervisor’s capacity (and skills) to exert judgment‐based discretionary interventions to slow down credit cycles, or restrict specific forms of intermediation that may become riskier as they develop. Given evolutionary uncertainty, macro‐prudential regulation cannot be entirely rule‐based. Instead, counter‐cyclical prudential norms may have to be at least in part judgment‐based, calibrated discretionally in view of changing circumstances, much as the interest rate is calibrated by monetary authorities.94 Of course, what shape and form such an instrument could take is hardly a trivial issue. The stronger powers of the “holistic” supervisor would also be accompanied by a tougher responsibility and, with it, a risk of calamitous failure. If things go well, financial market participants will reap the benefits and the supervisor would be an unsung hero. If things go wrong, moral hazard will have a field day: “it was the regulator’s fault, hence the state’s responsibility to pay for damages.” Moreover, initial success in stirring the system may breed complacency and irrational exuberance leading to a crash down the line. Avoiding these pitfalls will require combining hard‐wired rules (that maintain the system within reasonable bounds) with an institutional reform that is commensurate with the supervisor’s new terms of reference (including his enhanced powers and responsibilities), and sufficiently strong to overcome the multiple difficulties associated with the use of discretion. Finding the right implementation modalities and regulatory mix between rules and discretion is likely to be one of the toughest yet most central challenges of prudential regulatory reform in the years ahead.95 94 Indeed, reflecting more tenuous and complex links between the instrument and the final objective, a pure rule‐
based macro‐prudential policy could be even more elusive than a pure Taylor rule‐based monetary policy. Instead, having to explain and justify decisions could help promote progress on macro‐systemic prudential analysis, much as has been the case with inflation targeting for monetary policy. 95 In this context, to avoid regulatory capture, a particularly hard look will need to be given to the political economy of regulation (see Demirguc‐Kunt and Serven, 2009). This problem can become trickier when the supervisor needs to round off his views partly based on those who are closer to the market, including financial intermediaries. At the same time, however, players should realize that systemic adjustments should af...
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