After the 2008 financial crisis, safeguarding financial stability became an integral part of central banks’ mandate, alongside their traditional task of ensuring monetary stability. The renewed attention to systemic risk —a capacious category that encompasses a wide range of potentially significant threats to financial stability—has prompted an important shift from the predominantly microprudential pre-crisis paradigm of financial regulation and supervision, which focused on the safety and soundness of individual firms, to an explicitly macroprudential approach that targets system-wide effects of risk-taking by individual market actors. Central banks are at the core of this process, actively developing and implementing enhanced capital and liquidity standards for systemically important financial firms, conducting regular ‘stress test’ exercises, and pursuing other avenues of reducing systemic risk.
In a chapter contribution to an edited volume on central banking, I examine one particular aspect of this ongoing collective effort: reforming the institutional structure of the financial industry, or what is known as “structural reform.” A loosely defined term, “structural reform” refers generally to the process of establishing or redrawing the key regulatory and institutional boundaries that separate various types of financial services and service providers. By limiting the range of permissible transactions or organizational affiliations among different categories of financial firms, structural reforms alter the fundamental pattern of interconnectedness in the financial system. In that sense, reforming the institutional structure of the financial industry operates as a more blunt, deeper—indeed, foundational—form of the currently evolving macroprudential regulation. Consequently, I argue, financial sector structural reform constitutes a critical—though largely under-appreciated to date—dimension of central banks’ post-crisis systemic risk prevention agenda.
I start by identifying three principal models that form a continuum of potential financial sector structural reform choices: what I call the “universal bank” model, the “holding company” model, and the “strict separation” model. Applying this conceptual framework to analysis of post-crisis structural reforms in the U.K., EU, and U.S. allows us to develop a more systematic and coherent understanding of the similarities and differences in the dynamics of structural reform in different institutional settings. It also enables us to discern new, potentially broader aspects and implications of these reforms.
Specifically, this analysis helps to elucidate an important link between financial sector structural reforms, on the one hand, and central banks’ traditional spheres of activity, on the other. As a general matter, policing the structure of the financial sector is not viewed as one of central banks’ primary or direct responsibilities. Nevertheless, issues of financial industry structure are deeply, and inescapably, embedded in central banks’ current regulatory and policy agenda. As the chapter argues, this heightened post-crisis salience of industry structure on central banks’ agenda is both (a) a logical extension of their newly affirmed focus on safeguarding financial stability, and (b) an institutional response to the growing pressures on central banks to act as default regulators of ‘all things systemic’—and, as part of this de facto mandate, to fill the gaps that a successful structural reform of the financial industry ought to fill.
To illustrate this point, I examine the principal effects of structural choices on central banks’ jurisdictional reach, liquidity support function, substantive regulatory and supervisory mandates, and institutional capacity. On this basis, I argue that explicitly confronting these choices—and their effects—will help central banks to establish a more robust framework for pursuing their broad systemic stability goals. By contrast, failure to understand the full implications of structural reforms—and to assert a more cohesively articulated and public role in shaping their objectives and outcomes—threatens to make central banks’ post-crisis job more difficult to perform and less likely to bear fruit.
Saule T Omarova is a Professor of Law at Cornell University Law School.