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The Virtues of Prudential Regulation in Financial Markets

01/10/2004
Working Paper
Development

The potential of a properly regulated financial system to dampen rather than exacerbate shocks to developing economies has too often been overlooked. This chapter explores the potential of prudential regulations to dampen international capital flows, limit certain kinds of risk taking and help guard against systemic failures and international contagion.

Macroeconomics tends to focus on the policy efficiency of government budgets and central bank interventions to respond to economic shocks. This narrow focus has led the policy debate to focus on such matters as capital controls and transaction taxes.

This chapter analyzes a set of regulatory proposals that are designed for developing countries to remedy financial market short-comings and make financial markets and overall economies more efficient as well as less vulnerable to financial sector disruptions and distortions.