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Ethical Foundations of Financial Regulation

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  • Edward J. Kane

Abstract

Regulation consists of rulemaking and enforcement. Economic theory offers two complementary rationales for regulating financial institutions. Altruistic public-benefits theories treat rules as governmental instruments for increas- ing fairness and efficiency across society as a whole. Agency-cost theory recognizes that incentive conflicts and coordination problems arise in multi- party relationships and that regulation introduces opportunities to impose rules that enhance the welfare of one sector of society at the expense of another. Each rationale sets different goals and assigns responsibiliy for choosing and adjusting rules differently. Altruistic theories assign regula- tion to governmental entities who search for market failures and correct them. It is taken for granted that we may rely on a well-intentioned government to use its discretion and choose actions for the common good. Agency-cost theories portray regulation as a way to raise the quality of financial services by improving incentives to perform contractual obligations in stress- stressful situations. These private-benefits theories count on self-interest- ed parties to spot market failures and correct them by opening more markets. In financial services markets for regulatory service create outside discipline that controls and coordinates industry behavior. Institutions benefit from Institutions benefit from regulation that: enhances customer confidence; increases the convenience of customer transactions; or creates cartel profit. profits. Agency-cost theories emphasize the need to reconcile conflicts between the interests of institutions, customers, regulators and taxpayers.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 6020.

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Date of creation: Apr 1997
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Publication status: published as Journal of Financial Services Research, Vol. 12, no. 1 (August 2000): 51-74.
Handle: RePEc:nbr:nberwo:6020

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  1. Kahneman, Daniel & Knetsch, Jack L & Thaler, Richard, 1986. "Fairness as a Constraint on Profit Seeking: Entitlements in the Market," American Economic Review, American Economic Association, American Economic Association, vol. 76(4), pages 728-41, September.
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  7. John H. Kareken, 1983. "Deposit insurance reform or deregulation is the cart, not the horse," Quarterly Review, Federal Reserve Bank of Minneapolis, Federal Reserve Bank of Minneapolis, issue Spr.
  8. George J. Stigler, 1971. "The Theory of Economic Regulation," Bell Journal of Economics, The RAND Corporation, The RAND Corporation, vol. 2(1), pages 3-21, Spring.
  9. Michael J. Brennan, 1994. "Incentives, Rationality, And Society," Journal of Applied Corporate Finance, Morgan Stanley, Morgan Stanley, vol. 7(2), pages 31-39.
  10. Jensen, Michael C. & Meckling, William H., 1976. "Theory of the firm: Managerial behavior, agency costs and ownership structure," Journal of Financial Economics, Elsevier, Elsevier, vol. 3(4), pages 305-360, October.
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Cited by:
  1. Argandoña, Antonio, 2000. "Sobre la corrupción," IESE Research Papers, IESE Business School D/418, IESE Business School.
  2. Bear, Larry Alan & Maldonado-Bear, Rita, 2002. "The securities industry and the law," Journal of Banking & Finance, Elsevier, Elsevier, vol. 26(9), pages 1867-1888, September.
  3. Michael Beenstock, 2010. "Regulatory Failure in the Subprime Crisis," Open Economies Review, Springer, Springer, vol. 21(1), pages 147-150, February.
  4. Kane, Edward J., 2002. "Using deferred compensation to strengthen the ethics of financial regulation," Journal of Banking & Finance, Elsevier, Elsevier, vol. 26(9), pages 1919-1933, September.
  5. Larry D. Wall & Timothy W. Koch, 2000. "Bank loan-loss accounting: a review of theoretical and empirical evidence," Economic Review, Federal Reserve Bank of Atlanta, Federal Reserve Bank of Atlanta, issue Q2, pages 1-20.
  6. Donald P. Morgan, 1998. "Judging the risk of banks: what makes banks opaque?," Research Paper, Federal Reserve Bank of New York 9805, Federal Reserve Bank of New York.
  7. Larry D. Wall & Robert A. Eisenbeis, 1999. "Financial regulatory structure and the resolution of conflicting goals," Working Paper, Federal Reserve Bank of Atlanta 99-12, Federal Reserve Bank of Atlanta.
  8. Carlos E. Cuevas & Klaus P. Fischer, 2006. "Cooperative Financial Institutions : Issues in Governance, Regulation, and Supervision," World Bank Publications, The World Bank, number 7107, August.
  9. Kenneth Patrick Vincent O'Sullivan & Stephen Kinsella, 2011. "Financial and Regulatory Failure: The Case of Ireland," Working Papers, Geary Institute, University College Dublin 201136, Geary Institute, University College Dublin.
  10. Brunner, Gregory & Hinz, Richard & Rocha, Roberto, 2008. "Risk-based supervision of pension funds : a review of international experience and preliminary assessment of the first outcomes," Policy Research Working Paper Series, The World Bank 4491, The World Bank.
  11. McShane, Michael K. & Cox, Larry A. & Butler, Richard J., 2010. "Regulatory competition and forbearance: Evidence from the life insurance industry," Journal of Banking & Finance, Elsevier, Elsevier, vol. 34(3), pages 522-532, March.
  12. John Wagster, 1999. "The Basle Accord of 1988 and the International Credit Crunch of 1989–1992," Journal of Financial Services Research, Springer, Springer, vol. 15(2), pages 123-143, March.
  13. Schüler, Martin, 2003. "Incentive Problems in Banking Supervision: The European Case," ZEW Discussion Papers, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research 03-62, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research.
  14. Edward Kane, 2000. "Architecture of Supra-Governmental International Financial Regulation," Journal of Financial Services Research, Springer, Springer, vol. 18(2), pages 301-318, December.

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