Sunday, August 3, 2014

Regulation of finance and network industries

There are very interesting parallels between financial and network industries' regulation. Public interventions in network industries have historically addressed a number of concerns. Market power is perhaps the most prominent one, but there also concerns with externalities (positive and negative) and with asymmetric information. Equity concerns have also played a role, for example in universal service policies or secutirty of supply. Some of these policies have different time horizons: allocative efficiency concerns have typically a short run horizon but universal policy or security of supply have a longer run horizon. Some of the interventions operate ex ante (typically regulation), and others operate ex post (typically antitrust). Sometimes ex ante and ex post concerns are complementary and in other occasions theu are substitutes. These policies interact: for example, it is difficult to maintain universal service policy in the absence of new policy instruments when an industry is liberalized. In this sense, network industries are not very different from other industries, such as financial industries, where a number  of market failures and policy concerns interact, as the global financial crisis has made clear. A lender of last resort instrument (which has a clear distributive component) cannot exist without instruments of monetary policy, and the lender of last resort effectiveness depends on the effectiveness of policies of financial supervision (which have to do mainly with asymmetric information problems). And all these operates on an industry (banking) that is imperfectly competitive, and where the degree of competition, together with the degree of insurance guaranteed by the lender of last resort, affect the risks taken by agents (institutions and individuals). In the global financial crisis, market power concerns have clearly been trumped by the other concerns. Politicians are better at making decisions when the policy has far reaching redistributive implications so that compensation of losers is important; criteria of aggregate efficiency do not easily pin down the optimal policy; and if there are interactions across different policy domains so that policy packaging or evaluating controversial trade-offs is required to build consensus or achieve efficiency. The introduction of multi-dimensionality and distributive concerns in banking regulation and monetary policy after the global financial crisis has caused Central Bank independence becoming more vulnerable.
In the field of monetary policy and financial regulation, although banking supervision and monetary policy interact (as it is widely acknowledged after the global financial crisis), given the difficulty of measuring output on supervisory tasks, the systemic risk supervisor must necessarily be more accountable and less independent than central banks are on their monetary task. And since explicit incentives are not very useful, they must develop a strong culture and ethic, a sense of intrinsic preferences for doing their job well, because little credit is given if things go well, but a great deal of scrutiny and criticism are given if things go badly (specially for some interest groups). Although the literature argues that a single, large supervisory authority is better able to attract, develop and maintain professional staff expertise, this has not been found to be the case in other domains, where specialized agencies can offer a congenial environment to the experts in that field irrespective of size. Enlarging the focus of regulatory agencies has thus organizational and incentive costs. But as it was seen with the financial crisis (for example with the Northern Rock debacle in the UK), the central bank’s absence from supervision has also enormous costs.

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