Systemic Risk and Macroprudential Regulations

Global Financial Crisis and Thereafter

The Great Recession and Global Financial Crisis were, one would hope, teachable moments. In the aftermath of these roiling economic events, we have the potential to learn not only how to supervise and regulate our financial systems better but also how to ‘think’ about our economic systems better. The assumptions that markets are self-righting, that agents are rational and that asset prices convey the information necessary for efficient market clearing (to name a few) have all been profoundly challenged by the events of the recession and crisis. If we recognize that markets can sometimes be self-destructive, irrational and inefficient in transmitting information, we will do better in designing our financial systems to withstand the sorts of disruptions that arise from such behaviour. Dr Mishra’s book recognizes these shortcomings in our understanding of financial systems and explores in detail the multiple margins on which countries have made advances in making their systems more robust to the inevitable financial disruptions. In doing so, he provides a valuable compendium of views on the causes of the crisis, the consequences and the proposed solution. I can think of no one who is in a better position to do so than Dr Mishra, from his perch at the Reserve Bank of India.

The financial sector is truly global today with significant linkages between nations. The Global Financial Crisis beginning in the USA in 2008 spread fast and seriously disrupted many economies. Many a common man suffered and the anger lingers as people still believe that those responsible have not been held to account. Dr Mishra’s experience and perspective give him a unique perch. He provides a detailed analysis of the crisis, examines the technical, regulatory and ethical aspects, and suggests ways to work towards a more stable system. This is a valuable addition to the literature.

Dr Rabi Mishra was the first Chief General Manager of the Financial Stability Unit of the RBI that was set up in the aftermath of the 2007 Great Financial Crisis. His vision and enthusiasm helped to drive the agenda of getting data and models to help regulators to look at the risks in the Indian financial system in a more holistic way as befits macroprudential policy. Supported by the then Deputy Governor, Shyamala Gopinath, Dr Mishra was instrumental in mandating who-to-whom bilateral balance sheet data from major banks (including foreign banks in India) and non-bank financial institutions such as insurance companies and mutual funds. This was a first of its kind. I was brought in as senior consultant (2011–2014) to set up a digital financial network map and model the banking and financial market balance sheet interconnectedness for India. My brief was to give granular data visualization and provide a systemic risk metric that reflected the perils of leverage in the network of financial liabilities, and thereby avoid the pitfalls of paradoxical market price-based risk measures that underestimate risk when leverage is growing. I was impressed by the pragmatism and good sense of the RBI senior management who were refreshingly free of the dogma that blindsided their counterparts in the West. Having actively used countercyclical risk weights long before it became the mantra in the West and also through measures such as banning exotic options, the RBI regulators, in the run-up to the crisis and during it, had a better track record than many other central banks. I expect Dr Mishra’s book to reflect such sound principles of stewardship and openness to new holistic approaches for risk management.

The book is an excellent overview of the changing landscape for financial sector analysis and policies in the post-crisis world. Rabi Mishra discusses in-depth reasons why we now need to reorient financial sector surveillance towards monitoring the accumulation of systemic risk and how do the recent regulatory reforms including Basel III and the introduction of macroprudential policy help maintain financial stability. In the analytical area, attention is given to early warning systems and stress-testing—two key tools that were with us before the Global Financial Crisis but experienced substantial improvements recently to serve as useful guidance for implementing and calibrating macroprudential policy tools. Rabi Mishra does not stop here though; he opens additional topics on which there is no clear consensus yet, such as global coordination of monetary and financial sector policies and emergence of new risks that are under-researched as to their possible impact on future financial stability.

The Global Financial crisis had varied reasons and many ramifications. The world economic order has been reset, and it is important to capture full dimension and consequences of the crisis to learn the lessons and emerge as a stronger and more resilient nation.  This book evidently exhibits the significant macroprudential policies laid down by the regulators with an intent to counter the forces of crisis. I believe that this book is a  guide for the policymakers, researchers and academicians. The insights of Dr Rabi Mishra are incisive and perceptive. He has the fabulous ability to synthesize a complex topic into truthful simplicity.

This book has aptly described the evolution of macroprudential policy, taking examples of various causes of the Global Financial Crisis 2008 and the lessons learnt from it. Wearing a regulator’s hat, the author dwelt on post-crisis regulatory reforms to mitigate various risk elements and finally narrated a crisis management framework and stresstesting mechanism. The book is an interesting read for the students of economics as well as the practising bankers to gain a holistic idea about the subject.

Ten years since the GFC is a good time to evaluate the responses to it: their effectiveness determines whether we can prevent its recurrence. Dr Rabi Mishra has the knowledge and experience to undertake this task and the result is a compelling read for all concerned with the subject, that is, all of us.

This is a useful and important contribution to the debate about the forces that contributed to the global financial crisis. The book also provides a practitioner’s insights about what is needed to fix in financial systems so that they are less vulnerable to systemic crashes and also how to deal with such crashes if they do occur. 

Much has been written about the Global Financial Crisis—a defining event not just for the global economy but also for the economics discipline. Dr Mishra has written a wide-ranging book that is a worthy contribution to the debate.

In the ten years since the Global Financial Crisis, we have made great strides in understanding its causes and consequences, and perhaps most importantly, what might be done to avoid a similar catastrophe. Rabi Mishra’s book provides a thorough treatment of these lessons, and a fresh perspective, from someone who spent the time period sufficiently involved to develop a deep understanding, but sufficiently distant to avoid many potential biases.