The researchers' conclusion that larger banks should maintain capital relevant to their importance could actually promote innovation in the industry by favoring smaller, more agile banks, explained George Sugihara, a theoretical biologist at the Scripps Institution of Oceanography at the University of California-San Diego. Sugihara, a published proponent of similar approaches to regulating large banks, is familiar with the PNAS paper, but had no role in it.
"This would basically create a systemic-risk tax for larger more highly connected institutions and work to the advantage of smaller financial institutions," Sugihara said. "It is there in the small banks and thrifts that many publicly useful financial innovations arise."
The models the researchers created illustrate that such a policy is not only crucial, Sugihara said, but also potentially far-reaching and relatively simple to implement in comparison to existing, more complex regulations.
"This particular integration of network dynamics with confidence effects makes this model unique, and potentially both minimal and comprehensive," Sugihara said. "It calls attention to a general class of problem that has a long tradition in ecology but is only recently being taken seriously in central banking namely, the importance of evaluating risk by viewing banking as a 'whole' system."
Of elephants and illnesses
The researchers simulated a banking system inspired by models of ecosystems first developed in the 1970s by the PNAS paper's third author, Robert May, a professor of zoology at Oxford, a Princeton visiting professor in ecology and evolutionary biology, and former chief scientific adviser to the UK government. In ecology, these frameworks cast a holistic eye on how the interactions between different species can shape the stability of an ecosystem. In epidemiology, the consideration is the various av
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