Delays and Distorsions in Reforming Banking Regulation: A Political Economy Tale
24 Pages Posted: 29 Aug 2014
Date Written: August 2014
Abstract
After the 2008 Financial Meltdown the need to reconsider the separation between commercial banking and other financial risky activities - ring fencing - in order to mitigate systemic risks and to address the too big to fail problems was publicly recognized both in the United States and in Europe. In spite of this widespread demand for structural banking regulation reform, the ring fencing proposals - the Volcker Rule in the US Dodd Frank-Act, the Vickers Report in the UK, the Liikanen Report in the European Union - are still in their infancy. How to explain the difficulties in enacting structural banking regulation? The article presents a political economy view: the incumbent policymakers are politicians, and their personal cost and benefit analysis in introducing ring fencing can be different from the social one, when relevant private interests - the banking constituency - are present. The article sheds light under which economic and political conditions the structural regulation is likely to be postponed, modified or even distorted, using a formal model to discuss the ongoing legislative processes both in the US and in Europe. The article highlights that the actual degree of separation between commercial and investment banking can depend on a political cost and benefit analysis and it is likely to be different from the social optimal setting the more the politicians are influenced by banking lobbies.
Keywords: Great Crisis, Banking Regulation, Ring Fencing, Political Economy, US, Europe
JEL Classification: E44, G18, G28, H11
Suggested Citation: Suggested Citation