Edited by Christopher J. Green, Eric J. Pentecost and Tom Weyman-Jones
Chapter 4: Economic Evidence and Financial Regulation
Peter Andrews1 INTRODUCTION This short chapter summarises the main roles of financial regulators and draws attention to the important economic trade-offs that financial regulators have to make. It shows some of the ways in which the UK Financial Services Authority (FSA) has gathered the economic evidence needed to make these trade-offs in an informed way. It identifies an Occasional Paper, written for the FSA by David Llewellyn soon after the FSA was established, as an important catalyst for the FSA’s ground-breaking work in this area. It sets out the statutory context for using economic evidence in UK financial regulation and summarises the concepts laid down in the Occasional Paper. It then describes the FSA’s use of these concepts in its own approach to the economics of financial regulation. It briefly discusses criticisms of the FSA’s approach and a few of the results obtained by the FSA from using it. It identifies the further challenges that lie ahead if the FSA is to continue to improve the quality of its decisions by learning more about the interactions between financial regulations and financial markets that determine whether or not regulation is beneficial in practice. THE TRADE-OFFS FACING FINANCIAL REGULATORS: WHY THEY NEED ECONOMIC EVIDENCE Financial regulators face extremely difficult choices. Typically, financial regulation involves mandating prudential standards for financial firms, rules for market conduct and disclosures to be made to consumers. The first of these activities aims mostly to combat the negative externalities of firms’ failure.2 The third aims mostly to reduce...
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