Securities Law Prof Blog

Editor: Eric C. Chaffee
Univ. of Toledo College of Law

Sunday, February 14, 2010

Weber on Capital Adequacy Regulation

New Governance, Financial Regulation, and Challenges to Legitimacy: The Example of the Internal Models Approach to Capital Adequacy Regulation, by Robert F. Weber, Loyola University New Orleans - School of Law, was recently posted on SSRN.  Here is the abstract:

In the aftermath of the subprime credit crisis, recent academic and policy debate about the regulation and supervision of financial institutions has rightly focused on potential solutions to the manifold conflicts of interest and regulatory lacunae that exist in our current system. While most of these proposals concern the situs and scope of regulation, this Article contends that theoretical scrutiny of the methodologies and tools by which financial institutions are regulated - especially the modes of interaction between financial firms, their regulators, and other non-state stakeholders - are relatively under-scrutinized in financial regulation legal scholarship. This Article examines one financial regulatory reform - the recent trend of incorporating proprietary internal risk models in capital adequacy regulatory systems, most prominently the “Basel II” regime - and explains why it should be considered a so-called “new governance” technique aiming to bridge information asymmetries resulting from increasing complexity of regulated financial institutions. Despite its manifold advantages as a tool of governance in a highly complex and dynamic regulated field, this “internal models approach” to capital adequacy regulation falls into traps familiar to new governance reforms that render it susceptible to literal and softer forms of agency capture, and which threaten to compromise its democratic legitimacy and effectiveness.

My hope is that this Article, by analyzing a financial regulatory technology as a response to complexity from a new governance perspective, will prompt a deeper appreciation for new governance theory within financial regulation scholarship. New governance theory offers notable insights into the regulation of social systems dominated by complexity and dynamism, as with the contemporary financial system. By analyzing the complex financial system according to a new governance framework, scholars and policymakers will likely be able to (i) improve their diagnosis of sources of regulatory dysfunction, including in connection with the recent subprime credit crisis, (ii) propose reforms that will better conduce to the public goals of financial regulation, and (iii) deepen their understanding of the normative challenges to democratic legitimacy that are implicated when regulators seek to govern complexity through increased involvement of non-state actors in the regulatory process.

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