Justifying prudential regulation

In the wake of the GFC of 2008–2009, the terms systemic risk and macro-prudential regulation came to the forefront. Traditional banking regulation had largely disregarded systemic risk by focusing on individual institutions. This lack of a macro-prudential perspective, which is essential to preserve financial stability, constituted the main shortcoming of prudential regulation before the crisis. The traditional, micro-prudential regulation framework also failed by allowing banks to operate at very low levels of capital and to avoid controls through regulatory arbitrage and through soft supervision of key risks…