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Incentive audits : a new approach to financial regulation

Author

Listed:
  • Cihak, Martin
  • Demirguc-Kunt, Asli
  • Johnston, R. Barry
Abstract
A large body of evidence points to misaligned incentives as having a key role in the run-up to the global financial crisis. These include bank managers'incentives to boost short-term profits and create banks that are"too big to fail,"regulators'incentives to forebear and withhold information from other regulators in stressful times, and credit rating agencies'incentives to keep issuing high ratings for subprime assets. As part of the response to the crisis, policymakers and regulators also attempted to address some incentive issues, but various outside observers have criticized the response for being insufficient. This paper proposes a pragmatic approach to re-orienting financial regulation to have at its core the objective of addressing incentives on an ongoing basis. Specifically, the paper proposes"incentive audits"as a tool that could help in identifying incentive misalignments in the financial sector. The paper illustrates how such audits could be implemented in practice, and what the implications would be for the design of policies and frameworks to mitigate systemic risks.

Suggested Citation

  • Cihak, Martin & Demirguc-Kunt, Asli & Johnston, R. Barry, 2013. "Incentive audits : a new approach to financial regulation," Policy Research Working Paper Series 6308, The World Bank.
    • Handle: RePEc:wbk:wbrwps:6308
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    References listed on IDEAS

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    Cited by:

    1. Thorsten Beck, 2013. "Finance, growth and fragility: the role of government," International Journal of Banking, Accounting and Finance, Inderscience Enterprises Ltd, vol. 5(1/2), pages 49-77.
    2. Gordon Menzies & Peter Dixon & Maureen Rimmer, 2016. "In Praise of (Some) Red Tape: A New Approach to Regulation," The Economic Record, The Economic Society of Australia, vol. 92(299), pages 631-647, December.

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    Keywords

    Banks&Banking Reform; Debt Markets; Emerging Markets; Labor Policies; Insurance&Risk Mitigation;
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