Regulation and Supervision: An Ethical Approach
44 Pages Posted: 18 Aug 2013 Last revised: 24 Dec 2013
Date Written: November 18, 2013
Abstract
This essay shows that government credit-allocation schemes generate incentive conflicts that undermine the quality of bank supervision and eventually produce banking crisis. For political reasons, most countries establish a regulatory culture that embraces three economically contradictory elements: politically directed subsidies to selected bank borrowers; subsidized provision of explicit or implicit repayment guarantees for the creditors of firms that participate in the credit-allocation scheme; and defective government monitoring and control of the distribution of burdens and subsidies that the other two elements produce. In the years leading up to the panic of 2008, technological change and regulatory competition simultaneously encouraged incentive-conflicted supervisors to outsource much of their due discipline to credit-rating firms and encouraged lenders to securitize their loans in ways that pushed credit risks on poorly underwritten loans into corners of the universe where supervisors and credit-ratings firms would not see them.
Keywords: banking regulation, desupervision, regulatory competition, banking crisis, regulatory culture, regulatory norms
JEL Classification: D72, E58, G21, G28
Suggested Citation: Suggested Citation