Central Bank Regulation - John Lipsky

John Lipsky, First Deputy Managing Director at the IMF, delivered a speech on deficiencies in central bank regulation prior to the recent crisis plus some prescriptions for correcting shortcomings in Moscow last Friday. "The Road Ahead for Central Banks: Meeting New Challenges to Financial Stability".

He identifies a central failing which might be described as simple minded credulity.

Prior to the crisis, for instance, supervisors relied excessively on financial firms’ own risk analysis and internal controls. In broad terms, they relied heavily on the self-disciplining qualities of markets. In other words, supervisors were insufficiently intrusive and skeptical.

What could possibly go wrong with allowing firms to police themselves?  Not just allowing them to judge when they had "broken" a prudential limit, but allowing them to measure whether they had broken it or not.  And, we hear yet again about the self disciplining qualities of markets - which is the regulators' equivalent of the implicit guarantee. 

In fact if you read the speech carefully, you'll see that this failing is the root cause of most of the other shortcomings he identifies.