Abstract
Financial supervisory failure is often mentioned as one of the causes for the recent financial crisis. A possible explanation of this failure can be found in the absence of adequate incentives for financial supervisors. In the literature, accountability is considered an important mechanism to ensure that financial supervisors perform their supervisory role with adequate care. In this article I examine, using the insights from Law and Economics, to what degree accountability contributes to adequate financial supervision by examining the impact of the consequences of being held accountable on the behaviour of financial supervisors. The article shows that, from a Law and Economics perspective, it is unlikely that the existing accountability arrangements give the Dutch financial supervisors sufficient incentives for performing their supervisory role with adequate care. Given the fact that financial supervisors in Europe will more or less face the same consequences from being held accountable, it is likely that the outcome of this research will also apply to them.
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References and Notes
See Llewellyn, D.T. (1999) The Economic Rationale of Financial Regulation and Supervision. Financial Services Authority Occasional Paper Series No. 1, p. 9.
After the events at Northern Rock it became clear that the UK financial watchdog, the Financial Services Authority (FSA), failed to regulate Northern Rock adequately. The FSA said there had been a ‘lack of adequate oversight and review’ by the agency of the troubled bank. See the internal audit report of the FSA in 2008 (http://www.fsa.gov.uk/pubs/other/nr_report.pdf). US regulators failed to realize the massive risk American International Group's credit default swaps posed and should have stepped in sooner to stop the insurers from originating the products, according to the head of the Office of Thrift Supervision (see http://www.cnbc.com/id/2928855). In September 2009 it became clear the Securities and Exchange Commission had failed in uncovering Madoff (see http://www.sec.gov/news/studies/2009/oig-509.pdf).
See, for instance, Ward, J. (2002) The Supervisory Approach: A Critique. Cambridge Endowment for Research in Finance, Working Paper No. 02, p. 26, and Tabellini, G. (2008) Why did bank supervision fail? VoxEU.org, 19 March 2008, http://www.voxeu.org/index.php?q=node/994.
See Tabellini3.
See, for example, Kane, E.J. (1989) Changing incentives facing financial-services regulators. Journal of Financial Services Research 2: 265–274, p. 267, Tabellini,3 Ward,3 pp. 3 and 24, and Schüler, M. (2003) Incentive problems in banking supervision – the European case. Centre for European Economic Research, Discussion Paper No. 03–62, p. 5.
See, for example, Ward,3 p. 35 and Schüler,5 p. 12.
See Sullivan, A. and Sheffrin, S.M. (2003) Economics: Principles in Action. Upper Saddle River, NJ: Pearson Prentice Hall, p. 31.
It is likely that low wages will stimulate regulatory capture and thus lead to a situation in which financial supervisors do not pursue the public interest. See, for instance, Weder di Mauro, B. (2009) The dog that didn’t bark. The Economist 1 October, and Quintyn, M. and Taylor, W. (2002) Regulatory and Supervisory Independence and Financial Stability. IMF Working Paper, WP/02/46, p. 18. However, as already stated, I do not examine the effects of salary level on the performance of financial supervisory agencies in this article.
See Ward,3 p. 32 and Bovens, M . Schillemans, T and 't Hart, P . (2008) Does public accountability work? An assessment tool. Journal of Public Administration 86 (1): 225–242, p. 6, Amtenbrink, F. and Lastra, R.M. (2008) Securing democratic accountability of financial regulatory agencies – A theoretical framework. In: R.V. De Mulder (ed.) Mitigating Risk in the Context of Safety and Security. How Relevant is a Rational Approach? Rotterdam: OMV, pp. 115–132 (123), Hüpkes, E., Quintyn, M. and Taylor M.W. (2005) The Accountability of Financial Sector Supervisors: Principles and Practices. IMF Working Paper, WP/05/51, p. 8, Masciandaro, D. and Quintyn, M. (2006) Designing Financial Supervision Institutions. Independence, Accountability and Governance. Cheltenham, UK: Edward Elgar, pp. 157, 163.
See, for instance, Masciandaro and Quintyn,9 pp. 14, 45, 161 and Hüpkes et al9.
The Dutch financial supervisory agencies are the Financial Market Authority (AFM) and the Dutch Central Bank (DNB). Owing to the fact that financial supervisors in other European countries have many characteristics in common, the outcome of this analysis may also apply to them.
See Pratt, A. (2009) The political economy of financial reform: Effective regulations require effective regulators, VoxEU.org(a policy portal set up by the Centre for Economic Policy Research), 9 March, http://www.voxeu.org/index.php?q=taxonomy/term/1557.
Adequate care relates in this article to reasonable care. Reasonable care is the (legal) standard that is being used by Dutch courts to determine whether a financial regulator is liable or not. See, for instance, Van Dam, C. (2006) Liability of Regulators. London: British Institute of International and Comparative Law, p. 92.
See Dijkstra, R.J. (2009) Liability of financial regulators: Defensive conduct of careful supervision? Journal of Banking Regulation 10 (4): 269–284, p. 275.
The underlying model refers to the ‘Homo Economicus’. People, and thus also agencies, will act egoistically rational in that they will minimize the costs they are faced with in order to maximize their wealth.
See, for example, Masciandaro and Quintyn,9 p. 383. However, it should be noted that some scholars do not agree with the assumption that the principal-agent theory is an adequate way to analyse the relationship between the regulatory agency and the government. See, for example, Gilardi, F (2008) Delegation in the Regulatory State: Independent Regulatory Agencies in Western Europe. Cheltenham, UK: Edward Elgar, p. 4.
See Lavont, J.J. and Martimort, D. (2002) The Theory of Incentives. The Principal-Agent Model. Princeton, NJ: Princeton University Press, p. 3.
See, for instance, Alesina, A. and Tabellini, G. (2005) Why do politicians delegate? Harvard Institute of Economic Research, Discussion Paper Number 2079, p. 3, and Masciandaro, D., Nieto, M.J. and Prast, H. (2007) Who pays for banking supervision? Principles, practices and determinants. Journal of Financial Regulation and Compliance 15(3): 303–326, p. 311.
Besides the mentioned layers of agency problems, it is also likely that there exists an agency problem within the government and financial supervisory agencies. However, these ‘internal’ agency problems are no subject of research in this article.
See, for instance, Section 1:89 and further of the Dutch Act on Financial Supervision.
See Schüler,5 p. 13.
See, for example, Tullock, G. Seldon, A. and Brady, G.L. (2002) Government Failure. Washington DC: CATO Institute, p. 14, Masciandaro et al,18 p. 309 and Ward,3 p. 35.
See for the objectives of the Dutch financial supervisory agencies their website: http://www.afm.nl or http://www.dnb.nl.
See Singh, D. (2008) Banking Regulation of UK and US Financial Markets. Aldershot, UK: Ashgate Publishing, pp. 18–23.
See, for example, Schüler,5 p. 12, Masciandaro and Quintyn,9 p. 163 and Boot, W.A. and Thakor, V. (1993) Self-interested bank regulation. The American Economic Review 83(2): 206–212, p. 206.
This kind of behaviour is consistent with the ‘career concern model’ as presented by Alesina and Tabellini18 and Alesina, A and Tabellini, G (2008) Bureaucrats or politicians? Part II: Multiple policy tasks. Journal of Public Economics 92(3–4): 426–447, See also Ward,3 p. 35.
See, for instance, Mishkin, F.S. (1996) Understanding Financial Crisis: A Developing Country Perspective. National Bureau of Economic Research, Working Paper 5600, p. 16 and Masciandaro et al,18 p. 309.
See Weder di Mauro8.
See Sullivan and Sheffrin,7 p. 31.
See, for instance, Ward,3 p. 32, Bovens et al,9 p. 6, Amtenbrink and Lastra,9 p. 123, Hüpkes et al,9 p. 8.
See, for example, Hüpkes et al,9 p. 4, Litan, R.E Pomerleano, M and Sundararajan, V (eds.)(2002) Financial Sector Governance, World Bank/IMF/Brookings Emerging Markets Series. Washington DC, USA: Brookings Institution Press, p. 11, Masciandaro and Quintyn,9 p.14, Seelig, S. and Novoa, A. (2009) Governance Practices at Financial Regulatory and Supervisory Agencies. IMF Working Paper, WP/09/135, p. 17 and Singh,25 pp. 181–218.
See Bovens et al,9 p. 226.
See Amtenbrink and Lastra,9 p. 120.
See Hüpkes et al,9 p. 5.
See Amtenbrink and Lastra,9 p. 121.
See the Irish Times of 9 January 2009, http://www.irishtimes.com/newspaper/breaking/2009/0109/breaking75.htm.
See BBS NEWS of 11 February 2009, http://news.bbc.co.uk/2/hi/business/7883409.stm.
See IceNews of 25 January 2009, http://www.icenews.is/index.php/2009/01/25/icelands-minister-of-commerce-and-board-and-director-of-fsa-resign.
See the letter of the Dutch Minister of Finance of 29 October 2009 (FM/2009/2545 M).
See, for more examples of legal cases against financial supervisors, Tison. (2003) Challenging the Prudential Supervisor: Liability versus (Regulatory) Immunity’. Financial Law Institute. Working Paper 2003–04.
See, for instance, the article Nout Wellink: There are enormous gaps in our financial supervisory system in Vrij Nederland, 13 March 2009 and the article Nout Wellink lost authority in Elsevier, 24 October 2009.
See, for instance, the article ‘Parliament against the reappointment of Nout Wellink in Elsevier, 31 July 2009.
See, for example, Cooter, R. and Ulen, T. (2007) Law & Economics, 5th edn. New York: Pearson Addison Wesley. It should be noted that this model does not actually reflect the behaviour of people.
See Spitzer, M.L. (1977) An economic analysis of sovereign immunity in tort. Southern California Law Review 50: 515–548, p. 522.
Niskanen produced the first formal model focusing on decision makers in government, mostly bureaucrats. See Niskanen, W.A. (1971) Bureaucracy and Representative Government. Chicago, IL: Aldine Artherton.
See Dixit, A. (2002) Incentives and organizations in the public sector: An interpretative review. The Journal of Human Resources 37 (4): 696–727, p. 714.
See Dixit,47 p. 715.
See, for a detailed law and economics analysis of the impact of tort law on the behaviour of financial regulators, Van Dam26.
In October 2008 the Dutch Minister of Finance decided to increase the amount from €40 000 (with an own risk of 10 per cent for the last €20 000) to €100 000 for a period of 1 year. In October 2009 it became clear that the amount of €100 000 will remain for the period until December 2010.
See statistics Netherlands: http://statline.cbs.nl/StatWeb/publication/?DM=SLNL&PA=70813ned&D1=12-15&D2=a&HDR=T&STB=G1&VW=T.
See the letter of the Dutch Ministry of Finance FM 2006-01624M dated 17 November 2006.
See Dutch Parliament (2005–2006), publication 29 708, nr. 39, p. 12.
See Leaver, C. (2007) Bureaucratic minimal squawk behavior: Theory and evidence from regulatory agencies. University of Oxford. Discussion Paper Number 344, p. 2.
The distinction between direct and indirect relates to the fact that it is likely that some consequences not only have a direct impact on the private wealth or budget, but also contribute to reputation damage.
See Amtenbrink and Lastra,9 p. 124.
Acknowledgements
I thank David Llewellyn, Marc Quintyn, Rosa Lastra, Dalvinder Singh, Machteld de Hoon, Maurits Barendrecht and Dean Baker for their helpful comments.
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Dijkstra, R. Accountability of financial supervisory agencies: An incentive approach. J Bank Regul 11, 115–128 (2010). https://doi.org/10.1057/jbr.2010.1
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DOI: https://doi.org/10.1057/jbr.2010.1