A Tax on Systemic Risk

We advocate that systemic risk of the financial sector needs to be regulated, using a measure of an individual financial firm’s contribution to systemic risk that is based on Acharya, Pedersen, Philippon, and Richardson (2009a). We propose that each financial firm should be charged a “tax” based on its expected loss conditional on the occurrence of a systemic crisis. In our preferred approach, individual firms would be required to purchase contingent capital insurance, that is, insurance against the losses they incur during systemic crises. The cost of this insurance determines the firm’s systemic risk tax. We discuss why a joint privatepublic provision of such insurance has the right incentive properties to get the financial sector to internalize systemic risk. We provide an example of how such a systemic risk tax could be calculated and also discuss its relationship to other contingent capital proposals such as forced debt-for-equity conversions.

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