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Incentive audits : a new approach to financial regulation, Volume 1
Author:Cihak, Martin; Demirguc-Kunt, Asli; Johnston, R. Barry; Country:World;
Date Stored:2013/01/08Document Date:2013/01/01
Document Type:Policy Research Working PaperSubTopics:Emerging Markets; Banks & Banking Reform; Debt Markets; Labor Policies; Insurance & Risk Mitigation
Language:EnglishMajor Sector:Finance
Rel. Proj ID:1W-The Crisis And Beyond: Fy11-Fy13 -- -- P122136;Region:The World Region
Report Number:WPS6308Sub Sectors:General finance sector
Collection Title:Policy Research working paper ; no. WPS 6308Volume No:1

Summary: 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.

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