GoJIL Vol. 2, No. 1 (2010)
Beyond the Financial Crisis: Addressing Risk Challenges in a Changing Financial Environment
The Financial Crisis has not only highlighted the importance of addressing issues such as liquidity risk – it has also brought to the fore the need to focus on unregulated instruments such as hedge funds, which are of systemic importance to the financial industry. Risk is an area which, owing to its increasing significance, requires greater focus. A move to risk based strategies is evidenced by the growing popularity of risk based regulation and meta regulatory strategies. However, given the presence of an unregulated hedge fund industry such attempts are not sufficient on their own. Further, the systemic nature of risk exacerbates the problem of such unregulated institutions.
This paper aims to address complexities and challenges faced by regulators in identifying and assessing risk, problems arising from different perceptions of risk, and solutions aimed at countering problems of risk regulation. These issues will be approached through an assessment of explanations put forward to justify the growing importance of risks and well-known risk theories such as the cultural theory, the risk society theory and the governmentality theory. These theories will be considered against a background of themes such as dynamism, evolutionism, developments in science and industry, cultural attitudes to risk and the need to be responsive and reflexive to changes, which have arisen in modern society.
Theoretical models and hybrids of a responsive model of regulation such as enforced self regulation and meta regulation, which have the potential to address the problems relating to risk, will be addressed. By virtue of the pro cyclical nature of risk, the inability of Basel II to address risk cycles were revealed during the Northern Rock Crisis. Other flaws and deficiencies inherent in Basel II, a form of meta regulation, will be highlighted. The relevance of internal control systems to an efficient system of regulation, the reasons for which meta regulation is not only considered to be the most responsive form of regulation, but also one which assigns a central role to internal control systems will be discussed.
The contested nature of risk and the difficulties attributed to its quantification, raise questions about its ability to function effectively as a regulatory tool. If risks could be eliminated in their entirety however, then regulation would serve no purpose. Therefore, this paper aims generally to direct attention to those areas which could be addressed, namely institutional risks and measures whereby such risks, even though impossible to eliminate, could be minimized.
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