Financial systems are, in a manner of speaking, the ‘brains’ of the economic system. And while they are of key significance for dynamic economic development, they can also wreak havoc on an economy. In fact, a smoothly functioning financial system has, in a modern economy, at least four tasks essential for any sustainable growth process. First, by supplying businesses – and innovative businesses in particular – with newly created credit, the financial system sets the stage for investment and successful production processes. Second, by better distributing risk in general, it helps to enable business enterprises to assume more entrepreneurial risks and this tends to lead to higher levels of investment and greater economic growth. Third, a properly functioning financial system should distribute credit to those sectors and businesses that are most likely to generate sustainable growth. And fourth, one of the functions of a smoothly functioning financial system is to collect the smaller sums saved by a large number of savers and to make these resources available for major investment projects. In other words, the function of the financial system should be to make sufficient credit available for the business sector and to support innovative businesses with higher risks. This, though, can be done without either the countless – and, in the end, virtually indistinguishable – financial products currently available or huge derivative markets that tend to proliferate at dizzying rates. Furthermore, real estate and stock markets driven by speculation and short-term orientations and business strategies geared to earning quick profits offer little or no support for the long-term development of economies. Relatively down-to-earth financial systems are perfectly sufficient to expand credit and to finance investments and innovations.

What needs to be done
• Retention of a multi-tiered banking system with a strong public-sector component (savings and cooperative banks)
• Adoption of stricter rules governing the equity that banks are required to hold to cover all possible balance sheet risks; high risks need to be transparent and secured by sufficient equity
• Countercyclical formulation of financial market regulation (reduction of the role played by bank-specific quantitative risk models, reform of Basel II)
• Creation of a European banking oversight agency
• A strict ban on transactions with offshore centres
• Regulation of all financial institutions, keyed to their specific functions in the market
• Adoption of new rules on securitisation, including a licensing or testing agency for financial products and retention of the highest-risk shares when debt instruments are resold
• Setup of a clearing centre for derivatives and a strict ban on OTC transactions
• Expansion of the powers of banking and financial market oversight agencies, enabling them, in the future, to collect and aggregate financial market data and to adopt a macroeconomic perspective
• Abandonment of the principle of ‘fair-value accounting’ and adoption, in its place, of the lowest-value principle
• Reform of existing rating agencies and establishment of government rating agencies
• Adoption of strict rules for manager bonus systems
• Measures designed to correct the short-term orientation of financial markets and their impacts on the overall economy: abandonment of the shareholder-value principle in corporate management and measures designed to strengthen the role of all of a company’s stakeholders
• Expansion of the set of tools available to central banks to include, in addition to interest rate policy, variable equity rules for real estate credit (differentiated by sector and region) and the use of controls on the movement of capital and interventions in foreign exchange markets 

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