Financial Regulation and the Speed of Financial Risks

Abstract

This paper argues that the speed of financial risks, rather than the speed of regulators, is the key cause of financial crises. Our argument contradicts a common claim in the literature that financial crises arise because regulators cannot keep up with fast-paced changes in financial markets. We divide financial risks into two main types—fast-moving and slow-moving risks—and argue that most crises have been caused by slow-moving risks that regulators could have mitigated. The global financial crisis, however, showed that the mixing of fast-moving and slow-moving risks also leads to financial instability. This paper thus provides a novel argument for limiting risk-taking, potentially including the separation of financial institutions by the types of risk they manage.

Keywords

• financial regulation
• financial risk management
• banks
• bank holding companies
• Volcker rule