Document Type

Article

Publication Date

2017

Abstract

Although the relationship between credit availability and financial decline leading to the global financial crisis was somewhat interactive, a loss of credit availability appears to have caused the financial crisis more than the reverse. The potential for credit unavailability to cause a financial crisis suggests at least three lessons: (i) because credit availability is dependent on financial markets as well as banks, regulation should protect the viability of both credit sources; (ii) diversifying sources of credit might increase financial stability if each credit source is robust and does not create a liquidity glut or inappropriately weaken central bank control; and (iii) regulators should try to identify and correct systemwide flaws in making credit available. These systemwisde flaws can include not only financial design flaws but also flaws caused by our inherent human limitations. We do not yet (and may never) understand our human limitations well enough to correct the latter flaws. To some extent, therefore, financial crises may be inevitable. Financial regulation should therefore be designed not only to try to prevent crises from occurring but also to work ex post to try to stabilize the afflicted financial system after a crisis is triggered.

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Library of Congress Subject Headings

Financial crises, Credit, Loans, Default (Finance), Financial risk management

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