The Unassuming Economist

“By not reflecting liquidity risks in capital requirements, banking and insurance regulators have conjured up a dangerous system in which financial firms without liquidity take liquidity risks and financial firms with liquidity fail to do so. Two simple regulatory steps could change this system. Financial firms need to maintain a long-term stable funding ratio, and the regulatory risk weightings of assets should take into account the maturity of liabilities. These changes would encourage institutions with liquidity (life insurers, pension funds, and others with long-term liabilities) to provide it through instruments such as the self-rescheduling mortgage. They would also encourage banks to sell their illiquid assets to institutions with liquidity or lighten their dependency on short-term funding. The financial system as a whole would then be able to take long-term risks more safely. History suggests that safer housing finance would do more to make the financial system resilient than all the other recent initiatives put together”, according to Avinash Persaud of the Peterson Institute for International Economics.