[Show abstract][Hide abstract] ABSTRACT: This paper is one chapter of the volume “Regulation and Economics” of the second edition of the Encyclopedia of Law and Economics. The authors review the economics of banking and financial markets and the regulatory response to market failure. Market failure in finance depends on problems of information and externalities. Regulation addresses these problems through conduct of business rules and prudential requirements. This approach has recently proved insufficient to prevent financial crises. Governments and central banks had to step in with massive safety nets in order to prevent financial meltdown. Although the appropriate regulatory response to the global financial crisis is still to be discovered, this chapter tries to draw a few lessons for financial regulation and supervision. First, prudential regulation and supervision should monitor, and possibly limit, competition between banks and non-banks in order to identify timely new sources of systemic risk. Second, financial stability policies need to strike a difficult balance between ex-ante strictness and ex-post leniency in order to deal with non-quantifiable risks. Moral hazard is not the only determinants of systemic instability; knightian uncertainty also determines instability by suddenly curtailing market and funding liquidity. Third, all financial institutions falling within the regulatory perimeter should have good corporate governance. However, what is good governance for non-financial firms is not necessarily efficient for financial firms due to the quality and quantity of externalities involved. Finally, because systemic externalities are cross-jurisdictional in modern financial markets, at least coordination among monetary and supervisory authorities of different countries is warranted.
[Show abstract][Hide abstract] ABSTRACT: This article studies bank deposit insurance in the European Union (EU) and its likely effect on the member countries’ banking
industry. Deposit insurance is a relatively new phenomenon in the EU and has emerged because of the more competitive environment
now prevailing in the banking industry. None of the existing deposit insurance schemes approximates the optimal solution of
actuarially fair insurance premiums. Bank regulation and bank supervision have substituted for imperfect deposit insurance.
Consequently, the relevant focus of the analysis becomes the overall regulatory level rather than deposit insurance in isolation.
The home rule principle, embedded in the Second Banking Directive, creates incentives for countries to compete on regulations.
This competition, however, has a floor provided by a spate of EU directives that set minimum standards, including the very
recent directive on deposit insurance. Much remains to be done in the assignment of regulatory functions. The Maastricht treaty,
in fact, is relatively silent about the role of EU institutions, such as the European Central Bank, in maintaining the stability
of the EU banking industry.
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