NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Regulation and Supervision: An Ethical Perspective

Edward J. Kane

NBER Working Paper No. 13895
Issued in March 2008
NBER Program(s):Law and Economics, Monetary Economics

This essay shows that government credit-allocation schemes generate incentive conflicts that undermine the quality of bank supervision and eventually produce banking crisis. For political reasons, most countries establish a regulatory culture that embraces three economically contradictory elements: politically directed subsidies to selected bank borrowers; subsidized provision of explicit or implicit repayment guarantees for the creditors of banks that participate in the credit-allocation scheme; and defective government monitoring and control of the subsidies to leveraged risk-taking that the other two elements produce. In 2007-2008, technological change and regulatory competition simultaneously encouraged incentive-conflicted supervisors to outsource much of their due discipline to credit-rating firms and encouraged banks to securitize their loans in ways that pushed credit risks on poorly underwritten loans into corners of the universe where supervisors and credit-ratings firms would not see them.

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Document Object Identifier (DOI): 10.3386/w13895

Published: Regulation and Supervision: An Ethical Perspective Edward J. Kane The Oxford Handbook of Banking Print Publication Date: Jan 2012 Subject: Economics and Finance, Financial Economics, Public Economics and Policy Online Publication Date: Sep 2012 DOI: 10.1093/oxfordhb/9780199640935.013.0012

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