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The Atlanta Fed


New Atlanta Fed President Discusses Incentives-Based Approaches to Regulation of Financial Markets

EMBARGOED UNTIL 8:30 p.m. February 22, 1996

NEW ATLANTA FED PRESIDENT DISCUSSES INCENTIVES-BASED
APPROACHES TO REGULATION OF FINANCIAL MARKETS

MIAMI--In the opening address this evening of the fifth annual Financial Markets Conference held by the Federal Reserve Bank of Atlanta, Jack Guynn, the Bank's president and chief executive officer, called for practitioners and financial regulators to work together to develop a new regulatory paradigm that would be based on a dynamic rather than a static point of view.

Speaking about the dynamic world of financial markets, he focused on incentives-based approaches to regulation as a promising avenue. Guynn (pronounced "gwin") looked back at traditional approaches to regulation and then discussed the current internal models approach that allows banks with active trading accounts to use their internal risk management models to determine appropriate capital set-asides for market risk. "Clearly, relying on banks' own internal models is a giant step--a giant step away from inflexibility, rigidity, and a one-size-fits-all premise," he said.

But he urged participants to continue to open their minds to new methods, including the recently proposed precommitment approach, which would allow banks to specify the maximum expected trading-account loss over a given period and to set aside an amount of capital based on this level. Any trading losses above this limit would oblige the bank to pay a penalty. The main advantage of such a method, said Guynn, is that "properly designed, it would align a bank's incentives with regulatory goals."

While stating that traditional approaches still have their place, Guynn called for more research on the precommitment approach and other regulatory approaches that could be applied to financial institutions.

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