Complexity, Future of Financial Intermediation and Regulation

By Don Alexander, MBA
Associate, RSD Solutions Inc.
Mr. Alexander also lectures at NYU and SunySB

Since the onset of the financial crisis, what financial regulatory structure will deliver the right balance between growth and stability?  Finance and financial innovation are essential to growth, but finance is a two-edged sword. Indispensable for growth, the financial system can grow so large that it turns into a drag on activity. As recent events indicate, the fundamental links between the real economy and the financial system make it difficult to isolate the former from shocks originating in the latter.

This means that the size and structure of the financial system have aggregate real consequences. These externalities justify regulation.  And regulation, while necessarily focusing on the incentives and actions of individual agents and institutions, has systemic stability as its ultimate objective.  This is a question that Stephen Cecchetti, of the BIS, addresses is a recent speech The future of financial intermediation and regulation (October 2012).  What should the financial system look like 20 years from now, and how should we design financial regulation to deliver it?  Answering this question requires that we know what we want the financial system to do and what a financial institution is to look like – its size, scope and complexity – its appropriate role in the economy.

The main role of banks acting as intermediaries includes: pooling savings, safekeeping and accounting, providing liquidity, risk-sharing, extension of credit and information services.  In addition some of the larger banks provide: payment services across borders and currencies, underwriting securities for