An Institutionalist Framework for a Consistent Financial Regulation

Abstract:

In the light of recurrent systemic crises that financialized market economies have been experiencing since the 1980s, this article seeks to determine the conditions required for a regulatory framework apt to ensure financial stability. Drawing upon an Institutionalist Minskyian endogenous financial instability approach, the article studies the fragilities of liberalized finance and points to some policy alternatives able to lead to an alternative financial regulatory model that is consistent with macroeconomic stability. It argues that in a weak regulatory environment financial markets naturally generate instabilities that could turn into systemic crises. The analysis maintains that in order to deal with such crises, a tight supervision should be framed under the aegis of public authorities and suggests some rules to develop a relevant regulatory system through an open and democratic decision process. Two points then deserve particular attention: a macro-prudential approach that regards instability as a systemic (non-individual) issue, and a preventive approach that aims at preventing systemic-risk generating activities from taking control over the markets.

Keywords:

• central banking
• financial instability
• financial supervision
• institutions
• regulation

JEL Classification Codes::

• B52
• E61
• G01
• G18

Notes

1 Ben Bernanke (2010) reports that U.S. house prices began to rise rapidly in the late 1990s growing at 7–8% in 1998–1999, and 9–11% over 2000–2003. The most rapid price gains were in 2004/2005, when the rate of house price appreciation was between 15–17%.

2 The former Citigroup chief executive, Chuck Prince, notes: “When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing” (quoted in Sanati 2010).

3 Thus the concept of “institutional-time inconsistency” does mean that the rules and mechanisms in force are not consistent with systemic viability.

4 Profits, wages, salary, and bonuses.

5 George Stigler (1971, 3) views the issue in terms of allocative efficiency: “The central tasks of the theory of economic regulation are to explain who will receive the benefits or burdens of regulation, what form regulation will take, and the effects of regulation upon the allocation of resources.”

6 Faruk Ülgen (2019) suggests a public-good approach to financial system’s stability through an analysis of the specificities of financial markets.

7 It is worth noting that no debt can be repaid by itself. However, money—related to private debts—is used as a general means-of-settlement of debts thanks to the public power-based rules of the payments system. The role of the central bank as the lender-of-last-resort is therefore crucial for system’s working through time.

8 Conflicts of interest refers to a set of conditions that lead to confusion between a primary-interest related professional judgment (such as balance-sheet soundness) and a secondary interest (such as financial gain). See MacKenzie and Cronstein 2006.

9 Banks’ own Internal Ratings Based models (IRBs) and Credit Rating Agencies evaluations, all related to private-interest-based and profit-seeking strategies.

10 Institutions for occupational retirement provision.

11 Undertakings for collective investment in transferable securities.

12 Like the US Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, the European system of financial supervision in 2010, and the following regulatory reforms still in progress (see at : https://ec.europa.eu/info/business-economy-euro/banking-and-finance/financial-reforms-and-their-progress/progress-financial-reforms_en).

Additional information

Notes on contributors

Faruk Ülgen

Faruk Ülgen is an associate professor of economics and Deputy-Director of the Center of Research in Economics of Grenoble (CREG).