Institutional frameworks for financial stability

The implementation of prudential regulation and the execution of resolution policies face important institutional challenges. Basically, it implies a delegation of power to specific regulatory authorities. Delegation opens a series of principal-agent problems because the interests of a regulator (an agent) may not coincide with those of society (the principal). Hence, a clear specification of the agency’s mandates and tools, as well as correctly designed governance and accountability arrangements, are necessary to align incentives. The optimal design of the contract between society and regulators matters because it determines responsibilities, powers, constraints, and compensations. Also important is the architecture and institutional design of the safety net because it specifies the ways in which synergy among agencies must be exploited, as well as how checks and balances must operate…