Christian Noyer: A new regulatory framework for a new financial system Speech by Mr Christian Noyer, Governor of the Bank of France, at a round table discussion at the University of Paris-Dauphine, Paris, 11 December 2008. *  *  *  Ladies and Gentlemen, It is a great pleasure for me to take part in this round table discussion. Today, the prevailing view is – and justly so – that it is necessary to rethink financial regulation. There are two reasons for this: a)  Financial markets and banks are, more or less strongly, confronted with problems of asymmetric information;  b)  Operational inefficiencies may arise, leading, in some extreme cases, to the seizing up of certain market segments. Needless to say that these imperfections are interconnected. In many respects, the financial crisis is the expression of these imperfections. Three examples can be used as an illustration. The underestimation of risk and the mispricing of assets during the upswing of the financial cycle show that markets may generate excess investment in certain sectors of the economy (e.g. the US real estate sector). Furthermore, it appears that financial innovation and the change in banks’ economic models have resulted in a significant increase in information asymmetries and, more importantly, in lower incentives for economic agents to pay attention to these asymmetries. Lastly, the fact that some market segments seized up during the crisis suggests that some infrastructures necessary for their functioning are lacking.

Similarly, rating agencies should also be regulated, given the key role they play in correcting information asymmetries on financial markets. Lastly, public authorities should pay greater attention to those financial institutions that are central to the supply of market liquidity and financing. An important starting point is to acknowledge that financial system participants have very different functions, pursue different strategies and operate according to different economic models. This diversity is crucial to the smooth functioning of markets. A one-size-fits-all  BIS Review 161/2008  1  regulatory framework applied to all participants would certainly give rise to herd behaviour and, consequently, reinforce the endogeneity of certain risks. A gradation could reasonably be applied to the regulations and requirements imposed on financial system participants. Three levels, ranging from oversight to regulation, naturally come to mind. The first level would take the form of a mandatory registration and the commitment to comply with a code of good practices. The second – more restrictive – level would include disclosure obligations with regard to activities and accounts, in addition to the mandatory registration and the compliance with good practices. Hedge funds and, more generally, institutions pursuing strategies essentially based on leverage or risk-taking could have to meet such requirements. Finally, the last level would involve more restrictive regulations with regard to activities and risk-taking, as well as closer oversight. In many respects, this gradation system is not only relevant with regard to prudential requirements. It should also apply to accounting rules for example.