## Politically Robust Financial Regulation

_IMF Working Papers, January 8, 2021_

## Source details

**Canonical URL:** [Politically Robust Financial Regulation](https://www.imf.org/en/publications/wp/issues/2021/01/08/politically-robust-financial-regulation-49985)

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- [Markdown version](/en/publications/wp/issues/2021/01/08/politically-robust-financial-regulation-49985/index.md)
- [Structured JSON version](/en/publications/wp/issues/2021/01/08/politically-robust-financial-regulation-49985/index.json)
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## Bibliographic details
- Authors: Itai Agur
- Published: January 8, 2021
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781513566375.001

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### Summary
- The deferred recognition of COVID-induced losses at banks in many countries has reignited the debate on regulatory forbearance.
- The paper presents a model where the public's own political pressure drives regulatory policy astray, because the public is poorly informed.
- Using probabilistic game stages, the model parameterizes how time consistent policy is.
- The interaction between political motivations and time consistency is novel and complex: increased policy credibility can entice the politically-motivated regulator to act in the public's best interest, or instead repel it from doing so.
- Considering several regulatory instruments, the paper probes the nexus of political pressure, perverse bank incentives and time inconsistent policy.

### Model and methodology
- Framework: probabilistic game stages.
- Key parameter: time consistency of policy as parameterized by the model.
- Behavioral drivers: political pressure from a poorly informed public; politically-motivated regulator responses.
- Instruments considered: several regulatory instruments (unspecified in the overview).

### Main findings
- Public political pressure—rooted in poor public information—can mislead regulatory policy.
- Time consistency interacts with political motivations in non-monotonic ways:
  - Increased policy credibility can entice a politically-motivated regulator to act in the public's best interest.
  - Increased policy credibility can alternatively repel the regulator from acting in the public's best interest.
- Perverse bank incentives interact with political pressure to produce time-inconsistent regulatory outcomes.

### Policy implications and areas probed
- The analysis bears directly on the debate over regulatory forbearance in the context of COVID-induced bank losses.
- Policymakers should account for:
  - The role of public information quality in shaping political pressure.
  - How changes in policy credibility can have ambiguous effects on regulator behavior.
  - The combined effect of political pressure and bank incentives on time consistency of regulation.
- The paper examines implications across multiple regulatory instruments to illuminate the nexus of political pressure, bank incentives, and time inconsistency.

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## Content in this bundle

- **Working Paper**
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_Source: https://www.imf.org/en/publications/wp/issues/2021/01/08/politically-robust-financial-regulation-49985_