Financial regulation: It is the incentive effects that count

- "Banking and financial regulation is often analysed in a superficial way. For instance, finance and banks must be taxed because profits in these sectors are high; financial intermediaries must hold more capital to reduce the risk of going bankrupt."
- "But in order to be effective, financial and banking regulation must be based on the incentives it generates for financial intermediaries. Let us take a few examples:
taxing financial transactions is effective because it encourages holders of financial assets to hold on to them longer. A shortening of the holding period for assets actually generates a harmful variability, i.e. erratic capital flows to emerging countries, abnormal asset price volatility and discouragement of issuers and institutional investors;
taxing banks based on their total assets is most often counterproductive. It probably does not discourage the banks from engaging in excessively risky activities - but it probably encourages them to reduce the size of their balance sheet, and therefore essentially to reduce lending;
an increase in capital requirements for banks, not linked to the risk they take but a uniform increase (which is to a large extent the case with the changeover from Basel II to Basel III) does not lead banks to take less risk (which is the case when the additional capital is linked to the banks’ most risky activities), but either to reduce credit supply (to limit capital
consumption), or to take more risk (to obtain a return on the excessively large capital)."
- "It is therefore the specific incentive effects of financial regulation, and not its characteristics - which at first sight may seem suitable - that must be analysed."
Natixis Flash Economics 341 20100701

No comments:

Post a Comment