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Has Finance Made the World Riskier?


  • The author is the Economic Counselor and Director of Research of the International Monetary Fund. This paper reflects the author's views and not necessarily those of the International Monetary Fund, its management, or its Board. I thank Laura Kodres for extremely useful conversations and suggestions, Sergei Antoshin for valuable research assistance, and Douglas Diamond, Jonathan Fiechter, Laura Kodres, Donald Kohn, Hyun Shin, Jeremy Stein, and Hung Tran for valuable comments on a previous draft.

  • Keynote Address to the 2005 European Financial Management Association (EFMA) Meetings, Milan, Italy, 1 July 2005.


Developments in the financial sector have led to an expansion in its ability to spread risks. The increase in the risk bearing capacity of economies, as well as in actual risk taking, has led to a range of financial transactions that hitherto were not possible, and has created much greater access to finance for firms and households. On net, this has made the world much better off. Concurrently, however, we have also seen the emergence of a whole range of intermediaries, whose size and appetite for risk may expand over the cycle. Not only can these intermediaries accentuate real fluctuations, they can also leave themselves exposed to certain small probability risks that their own collective behaviour makes more likely. As a result, under some conditions, economies may be more exposed to financial-sector-induced turmoil than in the past. The paper discusses the implications for monetary policy and prudential supervision. In particular, it suggests market-friendly policies that would reduce the incentive of intermediary managers to take excessive risk.