Publication

Financial regulations in almost all countries are designed to ensure the soundness of individual institutions, principally commercial banks, against the risk of loss on their assets. This focus on individual firms ignores critical interactions between institutions. Attempts by individual banks to remain solvent in a crisis, for example, can undermine the stability of the system as a whole. As we saw with Bear Stearns, Lehman Brothers, and the UK bank Northern Rock in the current crisis, if one financial institution prudently reduces its lending to a second, the loss of funding may cause grave problems for the borrower.