Thomas J Jordan: Systemic risk and regulation – managing the challenges Speech by Mr Thomas J Jordan, Vice Chairman of the Governing Board of the Swiss National Bank, at the 5th Annual Meeting of the Swiss Finance Institute, Zurich, 3 November 2010. *  *  *  I would like to thank Dr. Claudia Strub, Till Ebner and Dr. Robert Bichsel for their valuable support in drafting this speech. Introduction The handling of systemic risk in financial systems is an immense challenge. First, because it is not always possible to pinpoint the precise sources of systemic risk due to complex interdependences in global financial markets. Second, because before the outbreak of a crisis it is almost impossible to identify which domino will be the first to fall and thereby bear the ultimate responsibility for causing the financial system suddenly to falter and even collapse. Finally, the impact of systemic risk can extend way beyond the system that is initially affected. When the financial system is close to collapse, the costs are enormous, as was clearly apparent in the latest financial and economic crisis. In my presentation today, I will talk to you about where we currently stand in our examination of the background to this latest crisis and how we can best address the diverse challenges in relation to systemic risk in the financial system.
However, irrespective of this fact, at this point I would like to stress how important it is that we use all the resources at our disposal to try and contain the effects of systemic crises or lessen the probability that such a crisis will occur, at the very least, even if we are unable to prevent crises altogether. First, systemic crises are enormously costly. Naturally, that alone does not justify state intervention. However, the legitimation for active state intervention can be derived from the fact that systemic risk gives rise to negative externalities, i.e. market failure, if it is not taken into account in the decision-making considerations of market participants. This means that the social costs of systemic crises are higher than the private costs. In the financial sector, this issue is particularly delicate, because of specific characteristics that can give rise to negative systemic externalities of the kind I have just described. 1 I will return to this important topic later in my presentation. Second, based on historic experience, I am convinced that both the magnitude of systemic risk and the probability that systemic crises will occur can actually be reduced through intelligent regulation. Sure, they can also be sharply increased by incorrect regulation or lack of regulation. Yet, improvement can be achieved even if it is not easy to identify the accumulation of systemic risk and even if regulation will never be perfect.