Description:
The main objective of this paper is to
rethink the use of market discipline for prudential purposes
in light of lessons from the financial crisis. The paper
develops the main building blocks of a market discipline
framework, and argues for the need to take an expansive view
of the concept. It also illustrates using actual bank case
studies from the United States its apparent failures in the
crisis, particularly the failure to prevent the buildup of
systemic, as opposed to idiosyncratic, risks. However, while
the role of market discipline in the design of
macro-prudential regulation appears to be largely
constrained, more can be done on the micro-prudential side
to promote clearer market signals of bank riskiness and to
encourage their use in the supervisory process.