Good Financial Regulation: Changing the Process is Crucial

Abstract

Good regulation can only come from having a vigorous public conversation on regulatory issues during normal times. Such an ongoing public exchange between regulators, the financial industry, and politicians would increase the probability of identifying emerging problems and the build-up of risks, and may also help forge a consensus in favor of preemptive remedial actions and interventions before stress on the financial system leads to crises. A few institutional changes that make the regulatory agencies financially and intellectually independent would help transform the current regulatory cycle and lead to a new type of engagement that would significantly raise the quality of supervision, regulation, and enforcement.

The past half century, and especially the experience of the last four years, has raised a number of fundamental questions about the nature and effectiveness of financial oversight and the functioning of regulatory systems. It seems that we not only fail to see the buildup of risks, but indeed have to wait until they materialize before we see fit to take action. As a result, reforms are largely undertaken in the aftermath of crises, precisely when it is most difficult to be deliberative and the resources to enact and implement are difficult to garner. If regulation were any other type of good or service, we would say that assuring good quality was a serious problem. And as is the case with most quality control problems, the answer is to re-think the production process.

In this essay, we offer a new vision of an improved production process for financial regulation. Good regulation can only come from having a vigorous public conversation on regulatory issues during normal times rather than in the heat of crises or in the midst of dealing with the economic and financial wreckage wrought by them. If such a conversation were possible, emerging concerns could be aired so that crises could be prevented or at least the severity of the fallout reduced. It would also drive the regulatory system to evolve in line with advances in technology and changes in the financial and nonfinancial sectors. And it would contribute to establishing and enforcing appropriate norms of behavior on all the players (including regulators). A few institutional changes would help transform the current regulatory cycle and lead to a new type of engagement that would significantly raise the quality of supervision, regulation, and enforcement.

Keywords: financial, regulation