Why Regulators Should Embrace DeFi

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Stress tests of major banks have repeatedly failed to uncover serious issues that have led to billions of dollars in losses – DeFi (decentralized finance) changes all of this.

Right now, the world’s financial system operates under a veil of secrecy.

Global banks currently undergo stress tests to examine whether they can withstand significant and sudden market downturns.

But in some cases, regulators only require these exercises to take place once every two years – and the outcomes can be unacceptably opaque.

It is only 16 years since Lehman Brothers spectacularly filed for bankruptcy in what was the world’s biggest commercial collapse ever.

Millions of high-risk mortgages had led to an unstable financial system, as well as a deep and punishing recession when the bubble burst.

Some lessons were learned back then. Scrutiny of major banks increased, and more aggressive affordability checks for home loans were imposed.

Yet despite tighter laws, closer oversight and more stringent stress tests, history keeps on repeating itself.

Just last year, yet another crisis unfolded – with the Bank for International Settlements describing it as “the most significant system-wide banking stress” since 2008.

Silicon Valley Bank, Signature and First Republic all suffered high-profile failures, while Credit Suisse endured a humiliating bailout and takeover by rival UBS.

In the space of 11 days, four banks with an astounding $900 billion in assets were shut down – creating a contagion effect and a crisis of confidence among consumers.

The Federal Reserve’s aggressive rate hikes exposed inadequate risk management procedures within these corporations, with losses on government bonds leading to large deposit outflows that dealt a fatal blow to their liquidity.

The fact that all of this could unfold so quickly painfully exposes the flaws that exist within stress tests.

Regulators are only getting a mere glimpse into the financial health of banks that billions of people rely on every day – and when things go wrong, they’re left playing catch up.

To make matters worse, inadequate levels of transparency are coinciding with an increasingly uncertain economic picture.

Federal Reserve Chairman Jerome Powell has once again admitted that inflation in the US is taking longer than expected to cool – and interest rate cuts may not come as soon as hoped.

The heightened cost of borrowing is causing mortgage defaults…