By Rob Daly

Time for a Systemic Risk Redux

Over the past decade, financial regulators have pushed for the reduction in systemic risk in the global markets but there is still much to do, according to academics.

“The banks that were too big to fail before the crisis are even bigger now,” said Deborah Lucas, professor of finance at MIT Sloan School of Management and director of the Golub Center for Finance and Policy, during a webcast hosted by the MIT Sloan School of Management. “Certainly we have not shrunk this size of those banks.”

Regulators have implemented a variety of reforms in the derivatives and other spaces regarding the transmission of risk, noted fellow participant Chester Spatt, a senior fellow at the MIT Golub Center for Finance and Policy as well as a former Chief Economist at the US Securities and Exchange Commission.

“We have tried to move to make expectations of bailouts less and also by requiring somewhat higher capital levels to have the banks internalize more of the risk they take and thereby somewhat modulating the risk in the banking sector,” he noted.

For Lucas, however, there are conspicuous absences when discussing post-2008 financial reforms- governments and their regulators. “The main risk that I see regarding systematic risk is the government’s unwillingness or inability to be the watchdog for itself regarding┬ásystemic risk,” she said.

Lucas noted that government agencies focus on their mandates but not the potential knock-on effects of those mandates.

“If you look at student loans, its mission is to make credit available to students,” she explained. “Its mission is not to stop that market from melting down and having repercussions into the rest of the market.”

Governmental contribution to systemic risk is far from just a US concern, according to Lucas. “In Europe, the riskiness of sovereign debt is a big concern,” she said. “There are capital regulators who still give sovereign debt a zero risk weight no matter how risky it is.”

Despite these regulatory concerns, regulators and the industry have done much to improve post-crisis financial stability, especially concerning risk transmission mechanisms, according to Spatt.

“Whether the particular envisioned mechanisms actually would be successful in the event of a crisis maybe not as clear but there certainly more thought on the resolution of large banks without, perhaps, bailouts,” he said. “How that would play out remains to be seen.”

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