Systemic Risk and the Role of Financial Innovation
Systemic Risk and the Role of Financial Innovation
An efficient market system encourages entrepreneurs to take risks by promising rewards, but also by implicating losses for any decisions that turn out to have failed. If the sanctions via potential losses and finally bankruptcy are removed, moral hazard is the consequence. Capital and liquidity regulations, resolution schemes and other measures have been presented to deal with this problem. Financial products could also play their role. An increasing share of the financial sector is, however, suspected of conducting a large portion of transactions not with respect to mitigating risks and providing for an efficient capital allocation but for its own sake and to the detriment of the economy. To strike a balance between innovation and safety, financial product transparency and guidelines for assessing a financial innovation’s potential impact on systemic risk should be developed.
Keywords: Systemic risk, Moral hazard, Resolution scheme, Financial innovation, Incentive structure, Transparency
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