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An Incentive Based Regulatory System: A Bridge Too Far

Author

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  • Rahul Dhumale

Abstract

This paper argues that the operation of the financial sector as a whole will not be as effective if market discipline is relied upon as the only tool of financial regulation. Before enacting any incentive mechanisms, there must be adequate built-in measures to prevent the exploitation of information asymmetries as well as greater harmonisation and co-ordination of regulatory standards between countries. The paper considers the "incentive problem" in regulation using a principal-agent framework and the design of an incentive compatible regulatory system which encourages prudent behaviour and efficient financial intermediation. The discussion continues by assessing the nature of the trade-off between incentive and rule based regulation by analysing the interaction between regulatory and agency incentives. The paper concludes by considering the challenges in designing appropriate incentive mechanisms to regulate financial markets.

Suggested Citation

  • Rahul Dhumale, 2000. "An Incentive Based Regulatory System: A Bridge Too Far," Working Papers wp170, Centre for Business Research, University of Cambridge.
  • Handle: RePEc:cbr:cbrwps:wp170
    Note: PRO-1
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    File URL: https://www.jbs.cam.ac.uk/cbrwp170/
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    References listed on IDEAS

    as
    1. Calomiris, Charles W., 1999. "Building an incentive-compatible safety net," Journal of Banking & Finance, Elsevier, vol. 23(10), pages 1499-1519, October.
    2. Joe Peek & Eric Rosengren, 1996. "The use of capital ratios to trigger intervention in problem banks: too little, too late," New England Economic Review, Federal Reserve Bank of Boston, issue Sep, pages 49-58.
    3. João Santos, 1998. "Commercial Banks in the Securities Business: A Review," Journal of Financial Services Research, Springer;Western Finance Association, vol. 14(1), pages 35-60, July.
    4. Frederic S. Mishkin, 1996. "Understanding Financial Crises: A Developing Country Perspective," NBER Working Papers 5600, National Bureau of Economic Research, Inc.
    5. Rahul Dhumale, 2000. "Capital Adequacy Standards: Are They Sufficient?," Working Papers wp165, Centre for Business Research, University of Cambridge.
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    Cited by:

    1. Paul Hamalainen, 2006. "Market discipline and regulatory authority oversight of banks: Complements not substitutes," The Service Industries Journal, Taylor & Francis Journals, vol. 26(1), pages 97-117, January.

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    More about this item

    Keywords

    Incentives; Market Discipline; Financial Regulation;
    All these keywords.

    JEL classification:

    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • G29 - Financial Economics - - Financial Institutions and Services - - - Other
    • G38 - Financial Economics - - Corporate Finance and Governance - - - Government Policy and Regulation

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