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

Director

Tommaso Padoa-Schioppa

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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