Free the Regulators

Corporate accounting scandals - indeed, the economic history of the last decade - demonstrate that global financial markets need politically independent regulatory agencies. The succession of financial crises that stained the 1990s had many and varied causes, but dysfunctional regulatory arrangements usually aggravated the effects. Each crisis exposed weak and ineffective legal frameworks (often deliberately maintained by politicians), inadequate and dispersed supervision, and forbearance policies that only an industry lobbyist could love.

Until recently, the independence of financial regulators and supervisors received only marginal attention. This is surprising, given that the case for central bank independence has been well established since the late 1980s. Over the past 15 years, as many central banks became legally independent from government influence, the results in terms of lower price inflation have become undeniable. Few now challenge the importance of central bank independence for achieving monetary stability.

Independence for financial sector regulators is as important as independence for central banks, and for many of the same reasons. Just as an independent central bank helps the private sector take long-term decisions based on a clear and stable set of rules, so an independent financial sector regulator can ensure that the rules of the regulatory game are applied consistently over time. If bankers know in advance that insolvent banks will be closed, and that lobbying to keep them open will not work, they will take fewer risks and the likelihood of their activities giving rise to a full-blown banking crisis will be reduced.

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