The Political Economy of Financial Regulation in Advanced Industrial Democracies

by

Richard Deeg, Walter James

• LAST REVIEWED: 26 November 2019
• LAST MODIFIED: 26 November 2019
• DOI: 10.1093/obo/9780199756223-0087

Introduction

The regulation of finance is central to the growth and development of every economy. Financial regulation determines the overall character of the financial system, the relationship between borrowers and savers, the allocation of capital, and the macroeconomic performance of the economy. Financial market regulation is distinct from regulation of other sectors of the economy because of the essential infrastructural role of finance—all other sectors of advanced economies depend on the financial system. Despite its enormous importance, financial regulation normally has low political salience. Except in times of crisis, most voters—and therefore politicians—have relatively little interest in the matter. This can be attributed in part to the complex and technical nature of financial markets and regulation, which relatively few people understand well. Low political salience facilitates a regulatory process that is very heavily shaped by regulators (technocrats) and the industry they regulate, with only minor direction from elected political leaders. In the long history of capitalism, bank and financial system crises have been regular occurrences. Regulation, or regulatory failure, is often seen as a cause of crises, but regulatory change is also the response. Thus any given financial regulatory regime is never settled for long. After the Great Depression, advanced capitalist economies introduced highly restrictive financial regulatory regimes designed to minimize systemic risk from bank failures. In the postwar period, restrictive regulatory regimes were combined with capital controls that limited international movements of capital. The postwar Bretton Woods international monetary regime stabilized fixed exchange rates through such controls and, when necessary, lending by the International Monetary Fund (IMF) to countries that could not pay for their external debts. Starting with the collapse of the Bretton Woods regime in the early 1970s, all the advanced economies started liberalizing financial market regulation and removing capital controls as part of a broader shift toward a neoliberal economic philosophy. These deregulatory measures brought about a dramatic transformation of domestic financial systems and the reemergence of a dynamic and rapidly growing international financial market. Such dynamic and internationalized financial market was, in large part, the root cause of the early-21st-century financial crisis. The Great Financial Crisis of 2008 precipitated widespread review and revision of financial market regulations at both the domestic and international levels. These revisions include a shift from private self-regulation to state-driven regulation of financial markets, the centralization of regulation at the level of the European Union, and a closer cooperation between states in forging international regulatory standards. Nonetheless, despite the dramatic growth of the international financial market and transnational efforts to coordinate regulation, financial regulation remains overwhelmingly a domestic affair.

General Overviews

There are several publications that summarize and analytically integrate significant portions of the literature on financial regulation. Deeg 2010 and Berger, et al. 2010 summarize shifts in domestic regulation and consequent changes in financial market structure. Cohen 1996 reviews much of the literature that analyzes the removal of capital controls and regulatory changes producing a reinvigorated global financial system. Helleiner and Pagliari 2011 and Duffie 2018 review literature covering the initial international regulatory responses to the 2007–2009 financial crisis. Deeg and O’Sullivan 2009 reviews literature that explores linkages between domestic and international financial regulation.

• Berger, Allen, Phillip Molyneux, and John O. S. Wilson, eds. Oxford Handbook of Banking. Oxford: Oxford University Press, 2010.

  Numerous chapters in this handbook address diverse issues of banking regulation at the domestic and international level.

• Cohen, Benjamin J. “Phoenix Risen: The Resurrection of Global Finance.” World Politics 48.2 (1996): 268–296.

  DOI: 10.1353/wp.1996.0002

  Reviews the literature, addressing the resurgence of global financial markets beginning in the 1960s. It examines explanations given for the return of financial globalization, as well as their economic and political consequences. One of the primary concerns of this literature is the implication of global finance for state sovereignty in managing domestic affairs.

• Deeg, Richard. “Institutional Change in National Financial Systems.” In Oxford Handbook of Comparative Institutional Analysis. Edited by Glenn Morgan, John L. Campbell, Colin Crouch, Ove Kaj Pedersen, and Richard Whitley, 309–334. Oxford: Oxford University Press, 2010.

  Reviews alternative conceptual frameworks for comparing national financial systems and their broader political-economic functions. Next it summarizes alternative approaches to explaining change in financial systems. The final section suggests how financial system typologies might be updated.

• Deeg, Richard, and Mary A. O’Sullivan. “The Political Economy of Global Finance Capital.” World Politics 61.4 (2009): 731–763.

  DOI: 10.1017/S0043887109990116

  Discusses three prominent issues in the political economy of finance literature since the mid-1990s: the partial shift in governance of financial markets from states to transnational regimes involving public and private actors as rule makers; the shift in many causal explanations toward a blend of institutions, interests, and ideas as variables; and an increased focus on new sources of systemic risk in the global financial system and their repercussions for states.

• Duffie, Darrell. “Financial Regulatory Reform after the Crisis: An Assessment.” Management Science 64.10 (2018): 4835–4857.

  DOI: 10.1287/mnsc.2017.2768

  This article surveys postcrisis financial reform in five key areas of regulation: (1) making financial institutions more resilient, (2) ending “too big to fail,” (3) making derivatives markets safer, (4) transforming shadow banking, and (5) improving trade competition and market transparency.

• Helleiner, Eric, and Stefano Pagliari. “The End of an Era in International Financial Regulation? A Postcrisis Research Agenda.” International Organization 65.1 (2011): 169–200.

  DOI: 10.1017/S0020818310000305

  Takes stock of international regulatory responses to the 2007–2009 financial crisis. It notes that scholars traditionally understand international financial regulation and coordination as occurring in three arenas: interstate, domestic, and transnational. The authors suggest that the outcome of the crisis may well not be strengthened international regulation, but less or weaker international regulation.