José De Gregorio: Lessons and challenges on financial regulation Introductory remarks by Mr José De Gregorio, Governor of the Central Bank of Chile, at the conference “Financial Regulation: Lessons from the Recent Global Crisis”, Santiago, 17 August 2009. I am very grateful to Luis Opazo for his contribution to this presentation. *  *  *  What went wrong? This question has been at the center of recent discussions in academic, practitioner and political circles, and will probably stay with us for several years. This conference is a step forward towards finding answers to this question. Specifically, the main purpose of the conference is to discuss those aspects of regulation that may have triggered or amplified the current crisis, and those aspects of regulation that in some countries have contributed to financial resilience. The Chilean financial system, as well as those of many other developing countries, has shown to be very resilient. Nevertheless, we also need to be involved in the discussions on building a safer financial system. Our countries have a lot to say on balancing financial innovation and financial soundness. The global economy shows some signs of recovery, but it is not evident that the crisis and its effects have fully unfolded. More likely, they will continue to evolve for some time. However, it is not too early to discuss these topics. Hence, we hope that the presentations and discussions of this morning will shed light on the directions for regulatory change in the upcoming years.
My impression is that the fundamental causes of the current crisis were the same market failures that have played key roles in many previous financial or banking crises, which we all know well from our previous experience in emerging markets. The first of these are the distortions in financial intermediaries’ behavior introduced by implicit or explicit bailout expectations. The second are the intrinsic vulnerabilities of financial intermediaries that finance long term (or illiquid) assets with short term debt. BIS Review 97/2009  1  What differs in the current crisis is the way in which these components showed up. As for excessive risk taking, the mechanism to deal with it was the securitization of high risk loans, which allowed banks to sidestep capital regulations by either creating off-balance-sheet agents or by bringing back loans packaged into highly rated assets, with low capital requirements. As for short term funding of long term (or illiquid) assets in the current crisis, this was prevalent in investment banks, SIVs and conduits. Hence, the lessons to be learned from the current crisis fall into two categories. The first are broad reforms that seek to align incentives and reduce the vulnerabilities of financial intermediaries. Higher capital requirements, a broader regulatory scope, and reforms to management incentive schemes are all in this category. These are all important aspects. However, the devil is on the details, and the exact way they should be implemented is yet to be defined.