Governing the Banking System: An Assessment of Resilience Based on Elinor Ostrom’s Design Principles

Abstract

The problem of financial stability is political and institutional, rather than narrowly economic. To achieve a more resilient financial system, we need to pay attention to the incentives of actors who have the power to act discretionarily, and to the knowledge limitations of such actors in the face of substantial complexity and uncertainty. The literature on polycentric governance and institutional resilience provides key insights that the literature on financial stability has thus far neglected. We offer an analysis based on the “design principles” for robust governance institutions proposed by Nobel laureate Elinor Ostrom. We apply these principles to banking systems and explore under what conditions a banking system can be expected to discover rules that align private incentives with broader financial stability, and generate the necessary knowledge to govern such a complex system. This perspective challenges both “microprudential” and “macroprudential” approaches which assume a monocentric financial and banking regulator.

Note: This is a substantially revised version of a Mercatus working paper, previously titled, "Governing the Financial System: A Theory of Financial Resilience."

Keywords: Central Banking, Elinor Ostrom, Financial Crisis, Financial Regulation, Free Banking

JEL Classification: E42, E44, E58, G28, P16