Chapter 9: Can Cost–Benefit Analysis of Financial Regulation be Made Credible?
Patrick Honohan 1 Introduction Finance has long been a relatively highly regulated sector of the economy. Safety and soundness of banks, avoiding fraud and abuses of information and power, and guarding against the use of the financial system to launder the proceeds of crime, have been the primary concerns of regulators. Yet, even if most of the financial system works well, there are still banks that fail, bankers that commit frauds sometimes on a massive scale, stock prices are manipulated and the gullible cheated. Every failure that comes to public notice gives rise to a clamor for additional regulation. But can more regulation really be justified, and if so of what type? Indeed, can current regulations be justified either by the scale of damage avoided or the success in avoiding it? Increasingly, appeal is being made to the methodology of cost–benefit analysis to resolve issues of this type. The trend towards requiring regulatory impact assessments (RIAs) for new regulations is firmly established, and these assessments are effectively applications of cost-benefit analysis1 – though the degree of rigor and thoroughness of the assessments varies widely. In particular, the new enthusiasm for regulatory assessment has not yet been matched by a comparable expansion in the collection and use of quantified information. All too often the effectiveness of any given regulation in achieving its objective is either taken for granted or justified by an external mandate (for example, a statute enacted by parliament or the result of adherence to international practice). Where quantification...
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