Research
CHAIR IN ECONOMICS OF FINANCIAL REGULATION
Mission
The following outlines the mission of the Chair in Economics of Financial Regulation (EFR).
1.1 Introduction
Efficiency and integrity are two sides of the same coin, when market rules are designed and applied in an effective way. Rules are effective if they are designed to serve the public interest by studying the choices of private individuals while. This assumption is particularly true for the banking industry and financial markets, where confidence goods are produced and distributed.
Devising mechanisms which produce both private and public efficiency means identifying rules which are consistent both with the general principles of economic analysis, as well as with the specific institutional context in which such rules are applied.
Two objectives are reached if this approach is applied. Firstly, virtuous physiological behaviors are stimulated and facilitated. Secondly, pathologies will have an isolated and individual character.
In the concrete layout of financial rules, it is necessary to search and then highlight the virtuous circle linking private aims efficiency and integrity public goals, which allows a clear distinction between physiology and pathology in economic behaviors.
A correct perception of what it means to promote both efficiency and integrity is a necessary condition for healthy and regular development of banking and finance. It is certainly in the interest of public actors and monitoring institutions that such a goal be reached.
But it is also in the interest of financial operators that a correct and up-to-date knowledge of the mechanisms which guarantee healthy and prudent management is developed, against the expected damages which are provoked by individual and specific pathological behaviors in industrial, commercial and financial businesses. Such behaviors often find fertile ground in the context of economic globalization and integration of financial markets.
If not governed by effective rules, globalization increases the risk of pathologies. The efficiency of rules, measured by the level of correctness of individual behaviors, depends on the ability to find a balance between the pursuit of the public interest and private interests. Correctness is an essential condition both for stability as well as for systemic efficiency. Wherever there is a reduction of correctness whether actual or only perceived the level of trust decreases and transaction costs rise.
Today, there exists a problem in the production and distribution of new knowledge around these issues.
1.2 Individual choices, public goals, rules
The analysis and evaluation of rules and supervision is a two-stage process: physiological and pathological. The first stage is physiological: the design of rules needs to keep in mind the diverse and varied interests in the market arena public, corporate, individual in order to make the most of their coherence. In other words, an alliance between efficiency and integrity (convenience and fairness) needs to be sought.
The central hypothesis of the entire methodological edifice hereby proposed is the following: the macro efficiency of rules must be founded on their consistency with the micro choices of operators and intermediaries. The first pillar is then the continuous search for consistency between social benefits accruing from the production of public goods such as effectiveness, integrity and stability and the private returns of individual choices.
Having defined these common values, their expression through rules reflects compliance costs for individual operators and corporate organizations. Making the cost of regulation compatible with individual target functions means going to the heart of the issue of best practice in business.
It is thus that the varied interests of economic agents can be in conflict with one another and, in the moment when a given rule defines their composition, any behavior which violates such rule turns into pathology. The second pillar of the joint safeguarding of efficiency and integrity is then the search for the best possible architecture in policies of preventing and sanctioning harmful behavior, in order to minimize the risk of deviancy.
It should be emphasized how the perception of the importance of regulation and supervision grows whenever significant pathologies in economic and financial systems come to the open. Pathology, keeping hyphoteses on individual and community values equal, can be born out of an ineffectiveness of rules. If individual conduct goes against the principle of correctness, one needs to wonder whether that violation requires reconsidering certain items of regulation or not. If thats the case, one needs to explore what is the right efficiency-integrity path to be pursued.
1.3 The need for new knowledge
There does not seem to be much of a trace, in the development of economic and financial knowledge and its diffusion among the various stakeholders and interest groups, of the approach based on the combination of efficiency and integrity, which allow to better investigate the physiology of relationships between regulation and individual choices, and thus recognize and isolate any pathologies.
The public interest is often expressed through an empty reiteration of the stated objective of efficiency, but this conflates two very different notions of efficiency: a macroeconomic one, such as in allocational efficiency, and a microeconomic one, having to do with operational efficiency in financial firms.
The pitfalls of bad knowledge and perception are particularly harmful to the regular development of the banking industry and financial markets. On the one hand, deviant conduct on the part of entrepreneurs and fraudulent administrators, or rather disloyal operators, causes damage to financial firms. On the other hand, the publics perception of the seriousness of such episodes tends to confuse pathology with physiology and individual actions with corporate behavior. These can cause considerable damages to assets and reputation. The threat to the fundamental intangible assets of the banking and financial industries is evident, as well as the negative effects to the countrys financial system.
Therefore it is necessary to increase the common knowledge and awareness of the importance of good design in financial rule-making. This is not an easy task. The search for the two pillars correctness and convenience for physiology, prevention and deterrence for pathology - is clearly a continuous dynamic process.
A process of production (research) and distribution (teaching) of new knowledge in the field of the economics of regulation and financial supervision needs to be started. Production and distribution of knowledge must have equal importance. The main body of economic and financial analysis must be strengthened, also through interchanges with the disciplines of law and business administration. The applied and institutional nature of problems should be dealt with by using a rigorous approach on both the analytical and empirical levels, by employing a comparative perspective, and attentive to international best practices, but always related to the national character of the issues under scrutiny.
Such is the mission which can be assigned to the EFR Chair. Within the Italian academic context, the EFR Chair is defined as pertaining to Economics (Economia Politica), with specialization in the field of financial regulation and supervision.
1.4 The meaning of the EFR Chair: Responsibilities of the holder
A knowledge gap needs to be filled concerning the topic of the optimal design of financial regulation and supervision. Academic activity can put itself at the service of such a goal of public interest, by supporting a long-term project which also supports the interest of the Chairs sponsor to attach his name to a high-profile scientific enterprise.
The EFR Chair must be a driver for the production and distribution of knowledge and therefore of research and teaching intertwined aimed at developing and spreading knowledge related to the economics of regulation and financial supervision. The Chair can represent a stable and unifying mechanism which promotes in a credible and consistent way over the long run specific research and teaching projects which are intertwined and coherent with one another. In such a way, the EFR Chair can be an original and innovative initiative in the national and international academic landscape.
The Chair holder shall guarantee that the mission hereby defined is respected in the creation and execution of research and teaching projects.
Ufficio responsabile: Paolo Baffi Centre
Author: Erika Somma
Last updated June 17, 2008
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