The Fundamental Principles of Financial Regulation

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The Fundamental Principles of Financial Regulation

Geneva Reports on the World Economy 11

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International Center for Monetary and Banking Studies (ICMB)

International Center for Monetary and Banking Studies 11 A Avenue de la Paix 1202 Geneva Switzerland Tel (41 22) 734 9548 Fax (41 22) 733 3853 Website: icmb.ch

? June 2009 International Center for Monetary and Banking Studies

Centre for Economic Policy Research (CEPR)

Centre for Economic Policy Research 53-56 Great Sutton Street London EC1V 0DG UK Tel: +44 (0)20 7183 8801 Fax: +44 (0)20 7183 8820 Email: cepr@ Website:

British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library ISBN: 978-0-9557009-7-2

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The Fundamental Principles of Financial Regulation

Geneva Reports on the World Economy 11

Markus Brunnermeier

Princeton University and CEPR

Andrew Crocket

JPMorgan Chase

Charles Goodhart

London School of Economics

Avinash D. Persaud

Chairman. Intelligence Capital Limited

Hyun Shin

Princeton University and CEPR

ICMB INTERNATIONAL CENTER FOR MONETARY

AND BANKING STUDIES CIMB CENTRE INTERNATIONAL

D'ETUDES MONETAIRES ET BANCAIRES

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International Center for Monetary and Banking Studies (ICMB)

The International Center for Monetary and Banking Studies was created in 1973 as an independent, non-profit foundation. It is associated with Geneva's Graduate Institute of International Studies. Its aim is to foster exchange of views between the financial sector, central banks and academics on issues of common interest. It is financed through grants from banks, financial institutions and central banks.

The Center sponsors international conferences, public lectures, original research and publications. It has earned a solid reputation in the Swiss and international banking community where it is known for its contribution to bridging the gap between theory and practice in the field of international banking and finance.

In association with CEPR, the Center launched a new series of Geneva Reports on the World Economy in 1999. The eight subsequent volumes have attracted considerable interest among practitioners, policy-makers and scholars working on the reform of international financial

architecture.

The ICMB is non-partisan and does not take any view on policy. Its publications, including the present report, reflect the opinions of the authors, not of ICMB or of any of its sponsoring institutions.

President of the Foundation Board Tommaso Padoa-Schioppa

Director

Charles Wyplosz

Centre for Economic Policy Research (CEPR)

The Centre for Economic Policy Research is a network of over 700 Research Fellows and Affiliates, based primarily in European universities. The Centre coordinates the research activities of its Fellows and Affiliates and communicates the results to the public and private sectors. CEPR is an entrepreneur, developing research initiatives with the producers, consumers and sponsors of research. Established in 1983, CEPR is a European economics research organization with uniquely wide-ranging scope and activities.

CEPR is a registered educational charity. Institutional (core) finance for the Centre is provided by the European Central Bank, the Bank of England, 33 other national central banks, 36 companies and the European Commission. None of these organizations gives prior review to the Centre's publications, nor do they necessarily endorse the views expressed therein.

The Centre is pluralist and non-partisan, bringing economic research to bear on the analysis of medium- and long-run policy questions. CEPR research may include views on policy, but the Executive Committee of the Centre does not give prior review to its publications, and the Centre takes no institutional policy positions. The opinions expressed in this report are those of the authors and not those of the Centre for Economic Policy Research.

Chair of the Board President Chief Executive Officer Research Director Policy Director

Guillermo de la Dehesa Richard Portes Stephen Yeo Mathias Dewatripont Richard Baldwin

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About the Authors

Markus K. Brunnermeier is the Edwards S. Sanford Professor at Princeton University. He is a faculty member of the Department of Economics and affiliated with Princeton's Bendheim Center for Finance and the International Economics Section. He is also a research associate at CEPR, NBER and CESifo, and an academic consultant to the Federal Reserve Bank of New York. He was awarded his Ph.D. by the London School of Economics (LSE), where he was also affiliated with its Financial Markets Group. He is a Sloan Research Fellow, and recipient of the German Bern?cer Prize granted for outstanding contributions in the fields of macroeconomics and finance.

He is primarily interested in studying financial crises, bubbles and significant mispricings due to institutional frictions, strategic considerations, and behavioral trading. His research also explains why liquidity dries up when it is needed most and has important implications for risk management and financial regulation. He is also an associate editor of the American Economic Review, Journal of European Economic Association, Journal of Finance, Journal of Financial Intermediation and was previously on the editorial board of the Review of Financial Studies.

Charles Goodhart, CBE, FBA is a member of the Financial Markets Group at the London School of Economics, having previously, 1987-2005, been its Deputy Director. Until his retirement in 2002, he had been the Norman Sosnow Professor of Banking and Finance at LSE since 1985. Before then, he had worked at the Bank of England for seventeen years as a monetary adviser, becoming a Chief Adviser in 1980. In 1997 he was appointed one of the outside independent members of the Bank of England's new Monetary Policy Committee until May 2000. Earlier he had taught at Cambridge and LSE.

Besides numerous articles, he has written a couple of books on monetary history; a graduate monetary textbook, Money, Information and Uncertainty (2nd Ed. 1989); two collections of papers on monetary policy, Monetary Theory and Practice (1984) and The Central Bank and The Financial System (1995); and a number of books and articles on Financial Stability, on which subject he was Adviser to the Governor of the Bank of England, 2002-2004, and numerous other studies relating to financial markets and to monetary policy and history.

Andrew Crockett is President of JPMorgan Chase International, and a member of the Executive Committee of JPMorgan Chase & Co. Before joining JPMorgan Chase, Mr. Crockett had been General Manager (CEO) of the Bank for

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