Regulatory Reform: Integrating Paradigms

42 Pages Posted: 20 Apr 2016

See all articles by Augusto de la Torre

Augusto de la Torre

UDLA, Centro de Investigaciones Económicas; Columbia University, SIPA

Alain Ize

World Bank

Multiple version iconThere are 2 versions of this paper

Date Written: February 1, 2009


The Subprime crisis largely resulted from failures to internalize systemic risk evenly across financial intermediaries and recognize the implications of Knightian uncertainty and mood swings. A successful reform of prudential regulation will need to integrate more harmoniously the three paradigms of moral hazard, externalities, and uncertainty. This is a tall order because each paradigm leads to different and often inconsistent regulatory implications. Moreover, efforts to address the central problem under one paradigm can make the problems under the others worse. To avoid regulatory arbitrage and ensure that externalities are uniformly internalized, all prudentially regulated intermediaries should be subjected to the same capital adequacy requirements, and unregulated intermediaries should be financed only by regulated intermediaries. Reflecting the importance of uncertainty, the new regulatory architecture will also need to rely less on markets and more on "holistic" supervision, and incorporate countercyclical norms that can be adjusted in light of changing circumstances.

Keywords: Debt Markets, Banks & Banking Reform, Emerging Markets, Labor Policies, Financial Intermediation

Suggested Citation

de la Torre, Augusto and Ize, Alain, Regulatory Reform: Integrating Paradigms (February 1, 2009). World Bank Policy Research Working Paper No. 4842, Available at SSRN:

Augusto De la Torre (Contact Author)

UDLA, Centro de Investigaciones Económicas ( email )

De los Granados y De los Colimes, Esquina
Quito, Pichincha

Columbia University, SIPA ( email )

420 West 118th Street
New York, NY
United States

Alain Ize

World Bank ( email )

1818 H Street, NW
Washington, DC 20433
United States

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