Regulatory Failures and Regulatory Capture

As bank failure can have serious consequences for individual customers, depositors and investors, as well as the economy, financial institutions are subject to a wide array of prudential regulations and supervisory review (see Chapter 6). Regulators, however, may fail to succeed in a number of ways. They may fail to regulate entire sectors of the housing finance system (regulatory blindness) or to exercise adequate supervision of the lenders and their intermediaries (regulatory myopia). Regulators may also be naive in failing to appreciate the risk of systemic crisis from the failure of too-big-tofail institutions or the risk of contagion across markets and countries. This chapter presents cases and examples that will be discussed under various types of regulatory failure (see Table 12.1). As was the approach in Chapter 11, for each type of failure, one example of problems encountered is drawn from the US experience and a second from another country’s. Another source of potential regulatory laxity and failure could arise from “regulatory capture”, when officials charged with overseeing business entities end up protecting the interests of the companies instead of the interests of taxpayers and the general public.