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Regulatory Capture by Sophistication

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  • Hakenes, Hendrik
  • Schnabel, Isabel

Abstract

One explanation for the poor performance of regulation in the recent financial crisis is that regulators had been captured by the financial sector. We present a micro-founded model with rational agents in which banks may capture regulators due to their high degree of sophistication. Banks can search for arguments of differing complexity against regulation. Finding such arguments is more difficult for a bad bank, which the regulator wants to regulate more strictly. However, the more sophisticated a bank is, the more easily it can produce an argument that a regulator may not understand. Career concerns prevent the regulator from admitting this, hence he rubber-stamps even bad banks, which leads to inefficiently low levels of regulation. Bank sophistication leads to capture, and thus to worse regulatory decisions. --

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Paper provided by Verein für Socialpolitik / German Economic Association in its series Annual Conference 2013 (Duesseldorf): Competition Policy and Regulation in a Global Economic Order with number 79991.

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Date of creation: 2013
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Handle: RePEc:zbw:vfsc13:79991

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  1. Laffont, Jean-Jacques & Tirole, Jean, 1991. "The Politics of Government Decision-Making: A Theory of Regulatory Capture," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 106(4), pages 1089-127, November.
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  6. Martin Hellwig, 2010. "Capital Regulation after the Crisis: Business as Usual?," Working Paper Series of the Max Planck Institute for Research on Collective Goods, Max Planck Institute for Research on Collective Goods 2010_31, Max Planck Institute for Research on Collective Goods.
  7. Friedrich Heinemann & Martin Schüler, 2004. "A Stiglerian View on Banking Supervision," Public Choice, Springer, Springer, vol. 121(1), pages 99-130, October.
  8. Oliver Board & Andreas Blume, 2008. "Intentional Vagueness," Working Papers, University of Pittsburgh, Department of Economics 365, University of Pittsburgh, Department of Economics, revised Aug 2008.
  9. Paul Milgrom & John Roberts, 1986. "Relying on the Information of Interested Parties," RAND Journal of Economics, The RAND Corporation, vol. 17(1), pages 18-32, Spring.
  10. Sher, Itai, 2011. "Credibility and determinism in a game of persuasion," Games and Economic Behavior, Elsevier, Elsevier, vol. 71(2), pages 409-419, March.
  11. Levine, Michael E & Forrence, Jennifer L, 1990. "Regulatory Capture, Public Interest, and the Public Agenda: Toward a Synthesis," Journal of Law, Economics and Organization, Oxford University Press, Oxford University Press, vol. 6(0), pages 167-98.
  12. Turkay, Evsen, 2011. "Evidence disclosure and severity of punishments," MPRA Paper 31504, University Library of Munich, Germany.
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