The Political Economy of Prudential Regulation

45 Pages Posted: 11 Nov 2020 Last revised: 29 Jun 2022

Date Written: September 3, 2020


This paper introduces a voting model into a framework with negative borrowing externalities to study how income inequality affects voter preferences for prudential regulation and the resulting equilibrium policy. When voting agents account for the general equilibrium impact of prudential policy on future asset prices and their access to credit. Consequently, borrowers support a universal limit on current debt. Curbing over-borrowing restricts future declines in asset prices, distributing wealth from high- to low-income borrowers, so the former prefer laxer regulation. Imperfections in enforcement distort the marginal value of regulation, so that borrowers who anticipate exemptions support an excessively strict policy. Imperfect enforcement can interact with income inequality to reverse the direction of the policy conflict between high- and low-income borrowers.

Keywords: political economy, financial regulation, pecuniary externalities, regulatory capture

JEL Classification: D62, D72, G28, H23, P16

Suggested Citation

Rola-janicka, Magdalena, The Political Economy of Prudential Regulation (September 3, 2020). Available at SSRN: or

Magdalena Rola-janicka (Contact Author)

Tilburg University ( email )

P.O. Box 90153
Tilburg, Noord-Brabant 5000 LE

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