Title: The Consolidation of Financial Regulation: Pros, Cons, and Implications for the United States
Abstract: During the summer of 2008, the House Financial Services Committee held hearings to consider proposals for restructuring financial regulation in the United States (U.S. Congress 2008). A Treasury Department proposal, released in March 2008, played a prominent role in the hearings. The Treasury proposal would consolidate by shrinking the number of financial regulators from the current six (plus banking and insurance regulators in most of the 50 states) to three: a prudential supervisor, responsible for assessing the riskiness of all financial institutions that have government backing; a consumer protection supervisor; and a market stability supervisor. Many other countries have either adopted consolidated financial regulation or are considering doing so. Four goals appear most frequently in the financial regulation consolidation literature: (1) take advantage of economies of scale made possible by the consolidation of regulatory agencies; (2) eliminate the apparent overlaps and duplication that are found in a decentralized regulatory structure; (3) improve accountability and transparency of financial regulation; and (4) better adapt the regulatory structure to the increased prevalence of conglomerates in the financial industry.1 These goals are difficult to achieve in a decentralized regulatory structure because of regulator incentives, contracting, and communication obstacles inherent in such a structure. Beyond the four goals found in the consolidation literature, an added motivation for modifying the U.S. regulatory structure arose during the period of severe market instability that began in 2007. That motivation is the desire to create a regulator that focuses heavily on market stability and systemic risk. While a consolidated regulator seems better able to achieve these four goals, countries that have consolidated their regulatory apparatus have spread decision-making authority among several agencies, thus undermining, to some degree, the potential benefits of consolidation. The desire to vest authority with more than one agency appears to be motivated by an interest in ensuring that an array of viewpoints temper regulatory decisionmaking so that financial regulation decisions, given their far-reaching consequences, are not mistakenly applied or abused. Further, regulatory consolidation, as frequently practiced in those countries that have consolidated, presents a conflict between, on the one hand, achieving the goals of consolidation, and, on the other hand, the effective execution of the lender of last resort function (LOLR-whereby a government entity, normally the central bank, stands ready to make loans to solvent but illiquid financial institutions). Under the consolidated model, the central bank is often outside of the consolidated regulatory and supervisory entity so does not have the thorough, day-to-day financial information that is beneficial when deciding whether to provide loans to troubled institutions in its LOLR role. This central bank outsider role is a potential weakness of the typical consolidated regulatory structure. One solution is to make the central bank the consolidated regulator; however, this poses difficulties of its own. There are several questions to consider before consolidating regulatory agencies in the United States. What drives financial regulation and how is it currently practiced in the United States? The Treasury proposal is the latest in a long history of consolidation proposals. What did some of these earlier proposals advocate and how does the Treasury proposal differ? What are the typical arguments for and against consolidation, what role do regulator incentives play in these arguments, and how have other countries proceeded? What are the features of the conflict between consolidation and effective execution of the LOLR function? 1. WHY THE GOVERNMENT REGULATES FINANCIAL FIRMS Government agencies regulate (establish rules by which firms operate) and supervise (review the actions of firms to ensure rules are followed) financial firms to prevent such firms from abusing the taxpayer-provided safety net. …
Publication Year: 2009
Publication Date: 2009-04-01
Language: en
Type: article
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Cited By Count: 9
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