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Regulation and Supervision: An Ethical Perspective

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  • Edward J. Kane

Abstract

This essay shows that government credit-allocation schemes generate incentive conflicts that undermine the quality of bank supervision and eventually produce banking crisis. For political reasons, most countries establish a regulatory culture that embraces three economically contradictory elements: politically directed subsidies to selected bank borrowers; subsidized provision of explicit or implicit repayment guarantees for the creditors of banks that participate in the credit-allocation scheme; and defective government monitoring and control of the subsidies to leveraged risk-taking that the other two elements produce. In 2007-2008, technological change and regulatory competition simultaneously encouraged incentive-conflicted supervisors to outsource much of their due discipline to credit-rating firms and encouraged banks to securitize their loans in ways that pushed credit risks on poorly underwritten loans into corners of the universe where supervisors and credit-ratings firms would not see them.

Suggested Citation

  • Edward J. Kane, 2008. "Regulation and Supervision: An Ethical Perspective," NBER Working Papers 13895, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:13895 Note: LE ME
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    File URL: http://www.nber.org/papers/w13895.pdf
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    References listed on IDEAS

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    1. Honohan, Patrick & Klingebiel, Daniela, 2003. "The fiscal cost implications of an accommodating approach to banking crises," Journal of Banking & Finance, Elsevier, vol. 27(8), pages 1539-1560, August.
    2. Barth,James R. & Caprio,Gerard & Levine,Ross, 2008. "Rethinking Bank Regulation," Cambridge Books, Cambridge University Press, number 9780521709309, March.
    3. Schüler, Martin, 2003. "How Do Banking Supervisors Deal with Europe-wide Systemic Risk?," ZEW Discussion Papers 03-03, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research.
    4. Edward J. Kane, 1998. "Capital Movements, Asset Values, and Banking Policy in Globalized Markets," NBER Working Papers 6633, National Bureau of Economic Research, Inc.
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    Cited by:

    1. Westman, Hanna, 2014. "Crisis performance of European banks – does management ownership matter?," Research Discussion Papers 28/2014, Bank of Finland.
    2. Westman, Hanna, 2011. "The impact of management and board ownership on profitability in banks with different strategies," Journal of Banking & Finance, Elsevier, vol. 35(12), pages 3300-3318.
    3. David G. Mayes, 2011. "Early Intervention and Prompt Corrective Action in Europe," Chapters,in: The Financial Crisis and the Regulation of Finance, chapter 10 Edward Elgar Publishing.

    More about this item

    JEL classification:

    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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