Congruent Financial Regulation
54 Pages Posted: 6 Apr 2021
Date Written: April 1, 2021
We propose a congruence principle for financial regulation. Application of this principle would enable regulators to use economically similar instruments across multiple domains to manage systemic risk. We present case studies of market malfunctions that occurred when congruence was ignored: nonprime mortgage finance (in 2008 and 2020) and United States Treasury securities (in 2020). In these cases, risk built up in non-bank financial institutions due in part to regulatory arbitrage. Under a congruence principle, regulators could mitigate this risk using a coordinated combination of capital requirements, minimum haircuts on repo transactions, and margining rules on futures exchanges and central clearing parties.
Keywords: financial regulation, systemic risk. shadow banking, repo
JEL Classification: G01, G18, G28
Suggested Citation: Suggested Citation