Sytemic Risk Responsibility

This section addresses the issue of which state body should be assigned responsibility for the oversight of systemic risk. Based on the arguments in the previous section, a case can be made for assigning both ex ante (surveillance) and ex post (crisis management) oversight to the same state body and this is the approach assumed in the section. Which state body should have these dual responsibilities is not clear, however, and most countries currently involve a number of different state entities in decisions with actual and potential systemic risk implications.

Given their existing roles in macroprudential surveillance and crisis management, central banks might appear to be the natural candidates for a central role in systemic risk oversight. As documented by Schinasi (2006), ADB (2008 a, b), and Davies and Green (2008), many central banks already have mandates for macroprudential or ex ante systemic risk oversight and are well positioned to track the build up of risk on account of their “need to know” the markets in order to implement monetary policy. And, in many countries, central banks still play a role in the micro supervision of the banks. In addition, by virtue of their lender of last resort and other related functions, central banks frequently play a major role in systemic crisis management, as documented in previous sections. From these perspectives, at least, central banks would appear to be well positioned to assume the dual roles of both ex ante and ex post systemic risk overseers. Such a role would, of course, require them to more formally take on some new and broader responsibilities (as discussed below)—and might require that the roles of other state bodies in these areas be cut back commensurately—but an expanded role might be seen as a natural fit as argued by Mishkin (2009) in the case of the US.

Against the arguments for providing central banks with a central role in systemic risk oversight, there are a number of important caveats. These include the possibility that the role of a systemic risk overseer will distract central banks from their focus on monetary policy; lead to them becoming excessively politicized as many decisions will need to be made about liquidity and other forms of support to financial firms; and, more generally, that it might involve central banks in many actual or quasi fiscal activities.⁶⁰ Moreover, given that micro-based supervision and regulation in several countries has already been moved outside the central bank—in one or more variants of the mega or integrated regulator model (Davies and Green 2008)—the proposal might require partially reversing this shift as central banks will require comprehensive information on the financial system in order to perform their expanded mandates or information sharing agreements would be required with financial regulators.

Alternatively, the systemic risk overseer role could be assigned to a mega financial regulator (outside the central bank) but this would immediately run into the difficulty that the mega regulator does not normally have the lender of last resort function or the other tools central banks have to manage crises. While it might be possible to provide the mega regulator with a lender of last resort fund on which it can draw during a crisis, this could seriously impede the flexibility to respond to shocks. Another possibility would be to assign the responsibility for systemic risk oversight to the ministry of finance based, inter alia, on its taxing responsibilities. This, however, could create a similar missing policy instrument as well as information sharing problems with the central bank and/or regulatory bodies. In short, there does not seem to be a simple solution to the issue of which entity should play the role of overall systemic risk overseer.⁶¹

Against this background, I would propose a compromise structure in which a single new state body is created to assume overall responsibility for ex ante and ex post systemic risk oversight even as the implementation of key policies with systemic risk implications remains at the central bank, the ministry of finance, and relevant regulatory bodies. As envisaged, a high-level systemic risk council (SRC) would be established in each country that would have the ultimate responsibility for systemic risk oversight and for setting macro prudential and crisis management policies. Under the envisaged structure, relevant state bodies, such as regulatory agencies, would continue to play important roles in micro-based supervision and regulation, central banks would continue to serve as lenders of last resort, and deposit insurance funds would discharge their mandates. What would be different would be that the activities and actions of these agencies as they relate to systemic risk would be under the direction and control of the SRC. Effectively, the SRC would be the one-shop coordinating agency for systemic risk oversight and control.

The power of the SRC would derive from its vested authority to require other state bodies, including the central bank, to implement the macro prudential and crisis resolution measures regarded as necessary to contain or manage systemic risk.⁶² To these ends, the SRC would need to have its own independent staff to assess and monitor systemic risk, be headed by an official with rank at least equal to the heads of relevant state agencies under its direction, and it would need to have the authority to request from other state bodies the information required to perform its functions.⁶³

⁶³

The SRC would be the ultimate point of responsibility for systemic risk oversight and management.

The SRC would monitor actual and imminent threats to systemic financial stability and have the responsibility to determine the appropriate pre-emptive macro-prudential policy responses that would be implemented by other state bodies.

The SRC would address unfolding systemic risks during crisis periods and have the responsibility for determining the macroprudential measures and state interventions required to address these risks in order to support financial stability.

The SRC would help coordinate the roles of the various state bodies and agencies as regards systemic risk (including the central bank) and help avoid duplication and overlap.

As envisaged, the SRC would be intended to address the key concerns that would arise in assigning systemic risk oversight to the central bank, while recognizing that several state bodies will invariably need to be involved in systemic risk issues. Most importantly, the SRC structure would help protect the monetary independence of the central bank and ensure that any quasi-fiscal actions (including the lender of last resort) that the central bank undertakes to contain systemic risk are implemented on behalf of the SRC with the risk borne by the SRC (and ultimately the government).⁶⁴ Beyond these advantages, the SRC would also be better positioned than the ministry of finance to decide when taxpayer funds should be used to address systemic risk concerns during a crisis. This is because the SRC, under its mandate, would be looking at systemic risk in deciding whether the use of public monies was warranted. And the establishment of the SRC would imply that the micro regulatory body (or bodies) would not need to focus on systemic risk or make decisions about the use of taxpayer funds in any bailouts during a systemic crisis.

Needless to say, the SRC would face a number of challenges in performing its mandate including those related to the fact that systemic risk oversight frequently involves the regular monitoring of markets in circumstances in which there are few dark clouds on the horizon. As with any other overseer of systemic risk, the challenge for the SRC will be to remain continually vigilant to the potential build up of systemic risk (while not sounding too many false alarms), to be able to take timely pre-emptive actions when risks appear on the horizon, and, in the event of crises, to be able to adopt a crisis management strategy that can contain systemic risk.

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