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Global Governance of Financial SystemsThe International Regulation of Systemic Risk$
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Kern Alexander, Rahul Dhumale, and John Eatwell

Print publication date: 2005

Print ISBN-13: 9780195166989

Published to Oxford Scholarship Online: September 2007

DOI: 10.1093/acprof:oso/9780195166989.001.0001

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Incentives versus Rules

Incentives versus Rules

Alternative Approaches to International Financial Regulation

Chapter:
(p.174) 6 Incentives versus Rules
Source:
Global Governance of Financial Systems
Author(s):

Kern Alexander (Contributor Webpage)

Rahul Dhumale

John Eatwell (Contributor Webpage)

Publisher:
Oxford University Press
DOI:10.1093/acprof:oso/9780195166989.003.0008

This chapter considers the role of market discipline and whether it can be relied upon as the only tool of financial regulation. It argues that if this is true, there needs to be at minimum an incentive-compatible framework in place a priori. The chapter begins by briefly considering the “incentive problem” in regulation using a principal-agent framework. It then considers the design of an incentive-compatible regulatory system that encourages prudent behavior and efficient financial intermediation. The discussion continues by assessing the nature of the tradeoff between incentive- and rule-based regulation by analyzing the interaction between regulatory and agency incentives. The chapter concludes by considering the challenges in designing appropriate incentive mechanisms to regulate financial markets through market discipline.

Keywords:   market discipline, financial regulation, incentive-based regulation, rule-based regulation, financial markets, incentives

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