June 04, 2019

The Advisory Scientific Committee of ESRB published a report that discusses how excessive regulatory complexity can contribute to systemic risk and possible ways to address the issue. The report establishes seven broad principles that would help make financial regulation more robust—adaptability, diversity, proportionality, resolvability, systemic perspective, information availability, and non-regulatory discipline.

The report starts with an explanation of the recent perceived increase in regulatory complexity and tries to identify the factors behind it. It then presents the channels through which regulatory complexity can contribute to systemic risk and the downsides of a simple regulatory framework. While it does not question the need for, or extent of, financial regulation, the report considers that the observed degree of complexity in financial regulation may limit its effectiveness in dealing with systemic risk. Some actions to address the current degree of regulatory complexity are presented in the last section of the report. To address systemic risk optimally, the report concludes that current financial regulation should be made more robust to uncertainty.

The report argues that complex regulation is not necessarily the best response to the complexity of the financial system. However, it calls for cost-effective and robust financial regulation rather than deregulation or overly simple regulation. Addressing regulatory complexity by promoting overly simple regulation would not generate an optimal outcome in terms of systemic risk. The regulatory framework would not be able to capture the inherent complexity of the financial system and would place excessive focus on reducing the regulatory burden, possibly at the expense of improving the incentive structure of regulated entities. In the long term, this could increase the societal costs of systemic crises. The report contributes to the ongoing debate on the optimal form of financial regulation, taking an approach focused on addressing systemic risk in the whole financial system within the context of a continuously evolving environment.

 

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Keywords: Europe, EU, Banking, Insurance, Securities, Regulatory Complexity, Systemic Risk, Proportionality, Resolvability, ESRB

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