Question

What reforms to the financial system might reduce its exposure to systemic risk?

Answer 1

Reforming the financial system to reduce systemic risk involves enhancing bank regulation, ending "too big to fail," preventing bailouts using taxpayer money, and stabilizing the flow of foreign capital through strategic reserves and prudent lending practices.

Step-by-step explanation:

To mitigate systemic risk in the financial system, several reforms can be implemented. These reforms aim to enhance the safety and stability of the financial system, which is essential both for protecting individual savings and for maintaining the integrity of the financial system as a whole. Following the 2008-2009 financial crisis, it became evident how critical these measures are.

Bank regulation is a keystone in minimizing systemic risk. Reforms in this domain often focus on improving accountability and transparency among financial institutions. For instance, requiring banks to maintain higher levels of capital and liquidity can act as a buffer against potential losses. Additionally, implementing stress tests to assess banks' ability to withstand economic downturns is a preventive measure taken by regulators.

Ending "too big to fail" is another reform strategy, which addresses the problem of certain institutions being so large and interconnected that their failure would have disastrous implications for the broader economy. Ways to end this include breaking up large banks into smaller entities or imposing stricter regulations on them.

To protect consumers and the economy, steps are being taken to end bailouts, which refers to the prevention of taxpayer money being used to rescue failing financial institutions. This could involve creating resolution mechanisms for systematically important banks so that they can be wound down without disrupting the financial system.

At an international level, to reduce exposure to abrupt shifts in foreign financial capital, countries are implementing various strategies. Holding large reserves of foreign exchange helps buffer against capital flight, while enhanced domestic bank regulation can prevent waves of imprudent lending. Moreover, encouraging long-term investment over short-term speculative capital inflows can stabilize the flow of foreign capital.

Answer 2

The Dodd-Frank Wall Street Reform and Consumer Protection Act

Step-by-step explanation:

The Dodd-Frank Wall Street Reform Act, which President Donald Trump wants to dismantle, generated an arsenal of rules to avoid excesses of the US financial sector that unleashed the 2008-2009 crisis.

Voted in July 2010 on the impulse of then President Barack Obama, that law forces bank giants sometimes annually to tests that measure their resistance to financial crises. It is a way to avoid catastrophic bankruptcies like that of Lehman Brothers in September 2008.

Large banks also have to make a "will" that allows their orderly dismantling if they fail and cannot return dividends to shareholders without the permission of the Federal Reserve (Fed).