Incentive Audits: A New Approach to Financial Regulation

31 Pages Posted: 20 Apr 2016

See all articles by Martin Čihák

Martin Čihák

International Monetary Fund (IMF)

Asli Demirgüç-Kunt

World Bank - Development Research Group; World Bank

R. Barry Johnston

International Monetary Fund (IMF)

Date Written: January 1, 2013

Abstract

A large body of evidence points to misaligned incentives as having a key role in the run-up to the global financial crisis. These include bank managers' incentives to boost short-term profits and create banks that are "too big to fail," regulators' incentives to forebear and withhold information from other regulators in stressful times, and credit rating agencies' incentives to keep issuing high ratings for subprime assets. As part of the response to the crisis, policymakers and regulators also attempted to address some incentive issues, but various outside observers have criticized the response for being insufficient. This paper proposes a pragmatic approach to re-orienting financial regulation to have at its core the objective of addressing incentives on an ongoing basis. Specifically, the paper proposes "incentive audits" as a tool that could help in identifying incentive misalignments in the financial sector. The paper illustrates how such audits could be implemented in practice, and what the implications would be for the design of policies and frameworks to mitigate systemic risks.

Keywords: Banks & Banking Reform, Debt Markets, Emerging Markets, Labor Policies, Insurance & Risk Mitigation

Suggested Citation

Cihak, Martin and Demirgüç-Kunt, Asli and Johnston, R. Barry, Incentive Audits: A New Approach to Financial Regulation (January 1, 2013). World Bank Policy Research Working Paper No. 6308. Available at SSRN: https://ssrn.com/abstract=2198264

Martin Cihak (Contact Author)

International Monetary Fund (IMF) ( email )

700 19th Street N.W.
Washington, DC 20431
United States

Asli Demirgüç-Kunt

World Bank - Development Research Group ( email )

United States
202-473-7479 (Phone)
202-522-1155 (Fax)

HOME PAGE: http://econ.worldbank.org/staff/ademirguckunt/

World Bank ( email )

1818 H Street, NW
Washington, DC 20433
United States

R. Barry Johnston

International Monetary Fund (IMF) ( email )

700 19th Street NW
Washington, DC 20431
United States

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