SOAS Research Online

Abstract

Market discipline and bank supervision can only operate if a bank’s risk profile is sufficiently transparent. In order to enable market discipline and bank supervision to function effectively, the complexity of major financial institutions must be reduced. Two different possibilities are discussed: one would not place any pre-determined limit on the size of financial institutions but would instead limit the government’s role as lender of last resort to narrow banks. The other would seek to reduce the size and complexity of all banks to a level where their collapse would not lead to the materialisation of systemic risk. It is argued that it is imperative that one of these solutions be adopted in order to avoid the possibility of an even worse financial crisis in the future.