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I wonder whether there exists (even a young) theory of financial regulation in the sense of "how to regulate a financial institution/system in an optimal manner"? I mean, there is experience about several situations which came across in the past, like bank runs, liquidity shortages, insufficient quality of regulatory capital etc. resulting in a crisis and, thus, representing a deviation from the optimal functioning of the financial system. This is then addressed by a regulatory reform which is designed to avoid exactly the experienced situation again in the future, i.e. it is specific to the current problem at hand. Is there something more general? The current approach focuses on ex-post fixing crucial issues, but does there exist a formal normative model or theory about regulating systems like the financial system? So far, I didn't found something about that but maybe others have? If not yet, maybe there exists some theory about other kinds of systems which one could apply in a modified version like Cybernetics for mechanical systems or the like?

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  • $\begingroup$ I do not want to write it as an answer because I do not know enough about it, but you may find interesting ideas in the Regulation School en.wikipedia.org/wiki/Regulation_school $\endgroup$ – Martin Van der Linden Nov 20 '14 at 21:06
  • $\begingroup$ This post has too many questions in it. Try splitting this into several different posts with only one (or two VERY similar) question(s) each. $\endgroup$ – Mathematician Nov 27 '14 at 18:24
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Jean Tirole just won the Nobel Prize for his studies in regulation in different markets, including the banking market.

Check:

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  • $\begingroup$ Thank you Diego for your answer, I will have a look at the books you've recommended. Am I right, when I suspect that the content of a book with the title "Balancing the Banks: Global Lessons from the Financial Crisis" is based on experience with issues from the past? So maybe I'm more looking for something like: "Is it theoretically possible to implement a kind of regulation which overcomes the time-inconsistency problem of the current approach?" A colleague already pointed to G. Soros' "reflexivity" in financial markets. Is this the direction to go? $\endgroup$ – Mikkel Nov 20 '14 at 15:58
  • $\begingroup$ @Mikkel I couldn't say, sorry. I'm not an expert on the topic. I think Jean Tirole is the way to go in general, but you would need to investigate more on the subject. If someone can extend the answer, you're welcome to do it! $\endgroup$ – Diego Jancic Nov 20 '14 at 16:24
  • $\begingroup$ This doesn't answer the question asked. If Tirole has produced a theory of optimal financial regulation, please summarise it here. Linking to content elsewhere is all very well, but it doesn't help build content on this site: it just sends visitors away. $\endgroup$ – EnergyNumbers Nov 27 '14 at 16:14
  • $\begingroup$ @EnergyNumbers to be precise, the question is whether something like that exists. And it would be really hard to explain the whole "theory of financial regulation". $\endgroup$ – Diego Jancic Nov 27 '14 at 17:20
  • $\begingroup$ @DiegoJancic well, quite. Hence a vote to close as too broad is appropriate. $\endgroup$ – EnergyNumbers Nov 27 '14 at 18:18
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This is a good question to ask, and the short answer is no there isn't. There probably should be, but the system itself is extremely complex and at the moment this is really the bleeding edge of research in Economics. It's an extremely involved subject, in no small part because the financial system itself is a moving target - it keeps being changed by regulation.

Tirole's research on market regulation, is a part of the larger puzzle, which properly framed would include detailed analysis of the banking system, the behaviours of different kinds of financial instrument, involvement of company structure and regulation, and probably the phase of moon. Well human behaviour has to be included somehow.

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