Should Financial Sector Regulators Be Independent?

Marc Quintyn, and Michael Taylor

• Publisher: INTERNATIONAL MONETARY FUND
• eBook ISBN:
  9781589063099
• Year: 2004

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Should Financial Sector Regulators Be Independent?

In nearly every major financial crisis of the past decade—from East Asia to Russia, Turkey, and Latin America—political interference in financial sector regulation helped make a bad situation worse. Political pressures not only weakened financial regulation generally, they also hindered regulators and the supervisors who enforce the regulations from taking action against banks that ran into trouble. In so doing, they crippled the financial sector in the run-up to the crisis, delayed recognition of the severity of the crisis, slowed needed intervention, and raised the cost of the crisis to taxpayers.

Increasingly, both policymakers and policy analysts are recognizing the need to shield financial sector regulators from political pressure to improve the quality of regulation and supervision with the ultimate goal of preventing financial crises. Surprisingly, however, few analyses have systematically discussed why independence for the financial regulatory agency might be desirable and how it might best be achieved.

This pamphlet investigates why financial sector regulators and supervisors might need a substantial degree of independence—not only from the government but also from the financial services industry—to fulfill their mandate to achieve and preserve financial sector stability. It also looks at the need for keeping regulators accountable as they exercise the (often) far-reaching powers delegated to them by their government.

Rationale for regulation

Regulators and supervisors in nations around the world are charged with managing the health of banks and other financial institutions and preserving the stability of the financial system. Governments regulate financial institutions for two main purposes. The first is consumer protection. This is much the same reason they regulate public utilities and telecommunications: to provide a framework of rules that can help prevent the excesses and failures of a market left entirely to its own devices. Second, regulation in the financial sector has the additional goal of maintaining financial stability, a clear public good that justifies a more elaborate framework of regulation and supervision.

Financial sector supervision, in particular, is more rigorous and intensive than supervision in other regulated sectors. Banking supervisors engage not only in off-site analysis of banks’ performance but also in extensive on-site inspections, and they intensify their monitoring and may intervene when banks fail to meet minimum requirements designed to ensure their financial soundness. Supervisors can even, in extreme cases, take ownership rights away from the owners of failed or failing financial institutions.

Banking regulation developed out of the concern of central banks to ensure financial stability. In many parts of the world, the central bank is the agency responsible for regulating banks, while, in others, it is a separate agency. In the nonbank financial sector, such as securities markets, insurance, and pensions, regulation has usually been conducted either by a central government ministry or by a specialist agency answerable to a ministry. The need for independent regulatory agencies has not, however, featured very strongly in public debates. In recent years, this has begun to change, driven by two important reasons.

Lack of independence worsens financial crises

In many of the world’s recent financial crises, policymakers in the countries affected have sought to intervene in the work of regulators—often with disastrous results. It is now increasingly recognized that political meddlin...

Table of contents

• Cover Page
• Title Page
• Copyright Page
• Contents
• Preface
• Should Financial Sector Regulators Be Independent?
• The Economic Issues Series
• Biography