The stronger powers of the holistic supervisor would

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Unformatted text preview: ard 47 At the same time, in contrast with universal banking, the proposed scheme would favor innovation and competition. Because they would not need to meet any entry capital requirements, unregulated intermediaries could start from scratch. This would facilitate the entry of the smaller players, possibly into “niche” or “boutique” intermediation. The most innovative and successful would eventually grow to become regulated and gain direct access to the capital markets. In turn, the most successful of the regulated non‐bank intermediaries could grow further to become universal banks, thereby authorized to tap deposits and take on full payment system responsibilities.86 The cost of oversight would remain low, however, as the activities of the unregulated would be monitored on a contractual basis by the regulated intermediaries that lend to them.87 This would effectively “delegate” supervision to the regulated intermediaries, creating a two‐tiered “nursery” system in which the start‐ups could prosper and grow under the watchful eye of the better‐established (and more experienced) institutions. Most importantly, this proposal does not rely on artificial boundaries set up by the regulator between “systemically important” and “systemically unimportant” financial intermediaries, based on size, activity, or some risk‐based measure of systemic impact (such as the recently proposed CoVar).88 Such distinctions are bound to create unending distortions or be very difficult, if not impossible, to implement operationally. If the distinction is based on a simple objective criterion, such as size, unregulated intermediaries could multiply and engage in “systemic herding”. They would individually benefit from the lighter regulation by staying just below the size threshold but become just as systemically important as a whole as in the case where unregulated intermediaries of any size were allowed to operate. On the other hand, risk‐based distinctions, even if based on meaningful and uncontested models (by no means an obvious proposition), are bound to create grey zones with an uneven playing field as regards both the intensity of regulation and access to the safety net. In such a context, reclassifying institutions in and out of the systemically important list is likely to be an operational and political conundrum. Instead, by treating all intermediaries equally subject only to a simple choice by the intermediary itself, our proposal is much simpler and operationally quite easy to implement. The second objective, particularly relevant to the externalities paradigm but also consistent with all three paradigms, is to keep the system reasonably close to a stable path (hence enhancing the scope for prices to reflect fundamentals) through a better alignment of incentives. In this regard, a key missing piece in the current framework is the internalization of systemic liquidity risk. Proposals have been made to penalize maturity mismatches between asset...
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