ISSN (Print) - 0012-9976 | ISSN (Online) - 2349-8846

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Causes, Cures and Myths

Our sights must be set on moderating the recurring cycle of financial crises and our solutions must go beyond the instruments, institutions or individuals of the day. Blaming offshore financial centres or the complexity of derivatives for the current problems misses the point. This article proposes counter-cyclical capital charges to push banks to develop incentive packages that are more encouraging of longer-term behaviour and a valuation method based on the relative maturity of an intermediary's funding. What the latter will do is allow any institution in a liquidity crisis to set up its own internal "bad bank" mechanism so long as it has sufficient long-term funding to support it.

The introductory section and the later section on mark-to-funding borrow heavily from my contributions to the 2009 Geneva Report on the Fundamental Principles of Financial Regulation, co-authored with Markus Brunnermeier of Princeton, Andrew Crockett, formerly of the BIS and Bank of England, Charles Goodhart of the London School of Economics, and Hyun Shin of Princeton University.

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