VoxEU Column Global crisis

Financial market systemic regulation: Stability through democratic diversity

Many observers blame regulatory failure for the financial crisis, arguing for closer international coordination of national regulation. This column argues for the opposite. Regulatory convergence creates instability. Instead, regulatory diversity is needed to reduce market herding and the resulting systemic risks. This diversity can be achieved through stronger democratic oversight of regulators.

An “independent regulator” is championed as meaning “independent of politicians” and without democratic accountability – no one seriously imagines it means independence from those it regulates. This is unfortunate.

All policymakers and regulators are critically reliant on strategic information. It is now accepted that in the run-up to the crisis the “models” relied upon were largely derived by specific market participants.

Granted, regulators need their own independent perspectives on the environments and entities they regulate – as argued by Ben Bernanke (2008). But, at a deeper level, the question remains why the regulators felt comfortable steering the ship with the use of information that was not their own?

One well-known yet understandably sensitive explanation is related to “regulatory capture” (see for example Moran 2002).

This column's explanation for regulatory incapacitation is regulatory convergence, leading to “groupthink” and an inability to think outside the box.

Regulator convergence could have resulted from capture, admittedly, but it might equally have resulted from a variety of other sources and conditions, such as; regulators’ international networking, political championing of the specific interests of certain commercial interests or centres, and/or regulatory rapture (Anderson 1985) – a condition in which regulators become openly ‘enraptured’ by their industry as distinct from being captured by it, predisposing them to do more or less what is asked of them.

New insight

I argue that networking between regulators and those they regulate results in a convergence of global regulatory thinking. This creates groupthink, common blind spots, and deepens systemic risk.

This can hardly be helped by yet more conformity. As one market commentator puts it:

“The intention [with the proposed European System of Financial Supervisors] is to write a “single rule book”, a laudable aim – until a national regulator disagrees. Would Spain, for example, have been allowed its sensible counter-cyclical bank provisioning system under such a model? For now, the question has been fudged and may remain so.” (Lex 2009)

For the sake of stability as a public good therefore, political diversity can and must intervene against the convergence of markets. Diversity could be achieved by politicisation of financial market regulation, displacing the current dominant idea that regulation is a technical, expert, “insiders” field. I am not arguing that regulators should not meet, cooperate and discuss issues. Rather, they should not form a closed clique whose agenda is not open to influence through the democratic process.

Competing concepts of regulatory shortcomings

Looking through the recent history, no doubt evidence and arguments could be offered for or against each of the above explanations – capture, rapture, networking. These concepts may have common elements, including lack of critical distance, exacerbated by introspective regulatory networking.

The simplest and yet most comprehensive explanation – and the least deniable one – may be international regulatory networking, exclusion of non-specialists, and a lack of real accountability to the public interest. In the context of lack of democratic accountability and external challenge, international networking of regulators and those they regulate unsurprisingly resulted in convergence of regulatory standards – and creation of common blind spots.

Certainly, regulatory thinking up until 2007/8 was influenced by private sector assumptions, models, data and mood – emotional over-optimism, if not intellectual capture. But the argument being made here is a much broader one. Any convergence, whatever its sources and its forms carries the dangers of groupthink and herding. What foundation might there be for a fundamentally different approach?

The need for democratic accountability

To reverse the trend of ever-increasing regulatory convergence, regulatory diversity needs democratic steering of regulatory agencies. This would overtly politicise financial market regulation, diluting if not displacing the currently dominant idea of regulation as a purely “technical” matter.

There would be strong functional advantages. Strong accountability of regulators to parliaments offers the prospect of diversity in regional and national regulatory regimes, since political constituencies may differ and change over time in their understandings of the issues and in their policy preferences. Democratically-fuelled regulatory diversity is a safeguard against the recently experienced frenzy in global financial regulation and markets.

Regulatory diversity would be underpinned by the democratic process operating at the national level, since it is still nation states that provide the primary channel for participation by parliaments and thus citizens in public policy. In the longer run, diversity between regional blocks might be underpinned by enhancement of democratic mechanisms at EU level and possibly also within other regional trade-based blocs.

Alongside such functional arguments, there are other reasons for robust democratic oversight of regulation by elected representatives in the public domain. If other policy areas are subject to political influence, especially when they involve public goods such as the climate, why not financial stability? Unless one can present grounds for exception, strong forms of accountability should be the rule. Parliaments provide accountability mechanisms, which should be strengthened in order to open up the regulators to scrutiny and to intellectual challenge.

Slim chance of a change

Parliamentary scrutiny, if taken seriously, could act as an important brake on the tendency for large firms and regulators to gravitate towards each other. But is this likely?

Although financial market regulatory reform is on the agenda internationally, with a variety of substantive and “architectural” proposals vying for attention and legitimacy, there is little appetite for more than gestures towards accountability. The ever-increasing stress placed on regulatory networking through international forums, such as the IMF or the G20, by definition worsens problems of accountability and convergence. In Europe, regulatory networking is being consolidated and further convergence seems inevitable, being welcomed by many (see for example Eijffinger 2009).

For the UK, a ‘Council for Financial Stability’ (Her Majesty’s Treasury 2009 and UK Parliament 2009) would at least once a year lay a report before Parliament. This style of communication is nowhere near taking political instructions. Not surprisingly, the Council’s report “may omit …anything in the report relating to any action to be taken by any of the relevant authorities the purpose of which may be impeded or frustrated by being included in the report laid before Parliament”. A seemingly sensible reservation – until one considers the retrospective nature of the Council’s reporting – then it smacks of undue shyness.


The prospect of a democratic re-shaping of financial market regulation is up against two barriers. First, the closed nature of technocratic networking between market participants and regulators, and second, the hardly-subtle threat that open debate of policy options could result in disaster. But these arguments are impressive only for those who forget that disaster has already happened under the current system. If changes are not made, we might as well sit back and wait for a replay.


Anderson, James (1982), “The Public Utility Commission of Texas: A Case of Capture or Rapture?”, Review of Policy Research, 1(3):417-629.

Bernanke, Ben (2008) “Addressing Weaknesses in the Global Financial Markets: The Report of the President's Working Group on Financial Markets”, 10 April, Washington DC: Federal Reserve System, pp 4.

Dorn, Nicholas (2009a), “The Governance of Securities: Ponzi Finance, Regulatory Convergence, Credit Crunch”, British Journal of Criminology, pp 23, 10 September.

Dorn, Nicholas (2009), “Systemic regulators’ accountability to parliaments: advantages for stability of global financial markets: a response to the UK Treasury White Paper on Reforming Financial Markets” 30 September pp 12.

Eijffinger, Sylvester (2009) “Adjustments to the accountability and transparency of the European Central Bank”, VoxEU.org, 24 October.

Her Majesty’s Treasury (2009), “Reforming financial markets”, Cm 7667, July, pp 176, London: Stationery Office.

UK Parliament (2009) “Financial Services Bill” November (1st reading), London: Parliament.

Lex (2009) “Europe’s new watchdogs”, Financial Times, 24 September, p 14.

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