Shadow banking and the moral hazard
Principles for reducing model-based opacity in securities finance
, 12 March 2012
When markets are unable to value an asset properly, financial intermediaries are in position to take advantage of other market participants. This moral hazard-problem is central to understand the destabilizing impact of shadow banking activities, and to effectively address problems involving valuation of complex financial instruments in illiquid markets. The guiding principles for regulation are straightforward: radical disclosure, shifted burden of proof and the rule of precaution applied to financial engineering.