Fundamental uncertainty and complexity need to be included in contemporary thinking on the economy. Adapting theory this way will lead to a different and improved type of supervision of banks, according to Prof. Lex Hoogduin in his inaugural lecture as Professor of Complexity and Uncertainty in Financial Markets and Financial Institutions at the University of Groningen, on Tuesday 22 April.
Hoogduin believes that the economy is not a system that is governed by quantitative laws, as nature is. The science of economics is more a description of the economic phenomena that we can see occurring every day. In addition, the economy is complex in the sense that not all information is concentrated in one place but is spread across all the economic actors. These two notions have yet to be included in the general macro-economic paradigm, despite this being called for, says Hoogduin.
Hoogduin states that these insights are necessary for better governance and supervision of the financial markets: ‘Once you admit that complexity and uncertainty are involved, you will indeed be able to develop instruments to deal with them. An individual bank is a complex institution because the information is not in any one place. Risk management works on the assumption that you can calculate risk, but this calculability is limited. But if you just accept that there is uncertainty and know that there will be surprises, you can then ensure, for example, that you develop a warning system that prevents nasty surprises, detection and information systems that keep you alert, and buffers that give you enough time to respond.’
Hoogduin illustrates his case with the supervision of the financial sector after the 2007-2008 financial crisis. Based on this theory it would be decidedly different from actual practice in a number of ways. ‘One difference would be that much less emphasis would be placed on risk-weighted capital requirements for banks and much more on the leverage ratio, which is a bank’s total balance in relation to its equity. The question of how much it may eat into its own capital, and whether and how the leverage ratio can then be restored, should be considered much more important. The current supervisory bodies would then also be deployed differently.’
Hoogduin expects these insights to open up new aspects of a field within economic science that has as yet hardly been explored. Scientific analysis is possible of the question of how people, businesses and governments deal with complexity and uncertainty. There are many interesting research questions which still need to be explored.’
The inaugural lecture of Prof. Lex Hoogduin will take place on Tuesday 22 April 2014, at 4.15 p.m., in the Aula of the Academy Building at Broerstraat 5 in Groningen. The inaugural lecture and the preceding symposium in the Aula will be streamed live via the University website as well as via www.lexhoogduin.com
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