Literature Review: Basel Accord and Politics
2.2 Domestic Political System
國
立 政 治 大 學
‧
N a tio na
l C h engchi U ni ve rs it y
2.2 Domestic Political System
Contrast to the power distribution analysis, in the following I review literature pertaining to domestic political factors. Literature regarding regulations, special interest group and political systems will be briefly examined and will be followed by their links to bank regulations. Critiques will be offered in the end of this section.
Existing literature has developed economic model to tease out the relationship between domestic politics and national regulations. Stigler (1971) argued that a state has coercion power that would change the subsequent wealth redistribution after a regulation has been introduced. Corresponding to Olsonian collective action hypothesis, he found evidence to support his argument that special interest groups, which are often composed of firms with small number and large size, possess greater resources and are better incentivized for desired regulations, which are more profitably to those groups at the expenses of others. This indicates that national regulations reflects the needs of interest groups formed by producers. Consumers, which constitute of mass public, are too weak to influence the regulatory results. Such phenomenon resembles
Addressing the problem of ignoring political pressure from the public, Peltzman (1976) also factors in political supports from the voters that can decide the political survival of the ruling authority. In his setting, regulators seek to remain in power and therefore has to evaluate the optimal balance between wealth and votes that realize political survival. The former usually comes from special interest groups through campaign contribution or indirect political support and the votes come from the society.
Following the same vein, Becker (1983) introduced a more sophisticated economic
‧
國立 政 治 大 學
‧
N a tio na
l C h engchi U ni ve rs it y
model that produce hypotheses of political pressures and regulatory results. He argued that if an interest group is more efficient at producing political pressure by using time, energy and money, it can successfully generate more subsidy to its favor. Such group often feature in its small size. Such line of literature indicate that to analyze domestic politics of bank regulation, one should first understand the feature of special interest groups and the public behind such regulatory regime. Frieden (1991) argued that the resulting distributional implications will force divergent domestic sectors to lobby for their own desired policies regarding the regulations of international capital mobility. To understand financial policies or regulations in a world of global finance, it becomes imperatives to investigate the underlying distribution of interests among different sectors. He extended such line of argument in accounting for the choices of exchange rate policies.
Through the lens of these models, a group of banks is the most important and powerful interest group in the regulatory process. The size of bank is typically large and the number of bank is not big, which in Stigler, Peltzman and Becker’s model can generate powerful political pressure to defend their interests. Since banks are financial intermediaries, the last thing they lack is abundant money. Banks are likely to raise funds more easily and less costly than other group for political pressures. In addition, retired bankers often join the regulatory agency in the government for their professional knowledge of arcane financial issues. Dinç (2005) found that government-owned banks (GOBs) finance much more money to public projects than the private banks. Such finding indicates that governments are more likely to secure funds is the relationship between it and the banks are closer, which creates high-level interdependent relationship. Huang, Shen and Lin (2011) echoed this arguing by providing Taiwan’s evidences that banks with higher political connections costs less in acquiring funds. The
‧
國立 政 治 大 學
‧
N a tio na
l C h engchi U ni ve rs it y
share structure of banks also relates to the easiness for banks to cooperate with governmental policies. If a country’s financial system is dominated by GOBs, banks are more likely to follow public policies. Sapienza (2004) found that GOBs’ lending behaviors are related to the electoral results. In the areas where banks are affiliated with dominant political parties, the interest rates are lower to serve the party’s political goal.
On the other hand, private-owned banks (POBs) are less likely and harder to be directed at political parties’ interests.
Admati and Hellwig (2013:193-207) commented that politicians, regulators, and supervisors often align themselves with bankers because politicians need financial resources, which is probably one of the most important factors for elections, from the banks and the banking sector need politician to act against tight bank regulation, which they consider would harm their profitability. In addition, financial regulators are often retired bankers from the industry and are more likely to act in favor to where he came from (Admati and Hellwig 2013:204-05, Braun and Raddatz 2009, Johnson and Kwak 2011). In this situation, regulatory capture is very likely to occur. Since the expected wealth to chief executive officers and managers of banks depends on banks’
profitability and to achieve this, investments of high risk are encouraged. Profitability and risk cannot attain at the same time. Therefore, banks are incentivized to take risk for higher profits (Shiller 2012, Singer 2007:13-19). As a consequence, any bank regulations that restrained the level of risk taken will be lobbying against by the banks.
Consequently banks are very likely to realize regulatory capture in their favor (Kwak 2014).
In addition to absolute level of bank regulations, banks also concern the relative laxity of bank regulation compared with other countries. This involves the concern of
‧
國立 政 治 大 學
‧
N a tio na
l C h engchi U ni ve rs it y
national banks’ global competitiveness. Financial firms are seeking to maximize their global competitiveness relative to banks from other countries. In Basel 1, Japan’s subsequent compliance can be attributed to pressures from the United States, which banking sectors lobbying hard against Japan’s relatively lax bank regulation (Gadinis 2008, Kapstein 1989, Singer 2004). In fact, not only domestic banks consider competitiveness important, national governments also value global competitiveness of banks in its jurisdiction for better economic performance. Thiemann (2014) argued that the reason why off-balance sheet securitization activities of banks remained mostly unregulated is because national governments’ concerns for losing competitiveness.
Therefore a leeway has been created for this innovative but risky financial products.
Bankers successfully capture weak financial regulation that serves its interest.
On the other hands, the larger and more diffused consumers of bank regulations, in Peltzman’s word, are general public. Since the potential costs generated from the bank regulations are vague and the financial business is extremely complex, it would be very hard for the public to cooperate to lobbying a bank regulation that redistributes wealth to them, or at least protect their interests. As a consequence, regulations asked by the banking sector seldom alert the public, which make banker’s regulatory capture more easily to realize. However, if the bank regulations fail to constraint banks’ risk adventure in a reasonable and controllable way, their deposits in the banks can be jeopardized due to bad investments, the occurrence of financial crisis or economic bad time. Should this happens and the banks confronts solvency or liquidity troubles, it is taxpayers’ money to pay the bill through governmental bailouts or bank insurance funds (Admati and Hellwig 2013).
However, the public often makes investment in financial firms and are incentivized
‧
國立 政 治 大 學
‧
N a tio na
l C h engchi U ni ve rs it y
to embrace financial system that encourage higher returns. In economic good time, the public with certain amount of financial investment can be encouraged to stand side by side with the banks in lobbying for more competitive regulations. But in the economic bad time, especially when they are aware that lax regulations lead to financial crisis and cause losses, the public can be more likely mobilized for higher level of bank regulation.
In a nutshell, although bank regulation can be a game between bankers (money) and the general public (votes), the nature of such regime inevitably makes national bank regulation to reflect better to the interests of large, concentrated, efficient, and resourceful banks rather than small, diffused, and relatively poor public individuals.
However, the issue of exogenous shock or time can raise public’s influence. Financial crisis is likely to arouse public awareness for a safer, less risky, national financial system. In addition, several research found out that governmental regulators are not likely to let the failed banks collapse when the national election is upcoming (Brown and Dinç 2005, Liu and Ngo 2014). This also means that during non-election year, when politicians care less about campaign contribution but more about public performance, the interests of general public are more likely taken into consideration in the regulatory agencies.
Clearly, the domestic bank regulations can be treated as a tug of war between stronger and informative bankers, and weaker and more ignorant public. However, how does the interaction of these two forces interact with different kinds of political systems remains unclear. Milner (1997) considered a close relationship between international cooperation and domestic political institutions. In her game-theoretic setting, a national government first discusses and negotiates with foreign governments on a certain international coordination scheme. After this process, the government takes the negotiation results back home and is subject to the checking mechanism exerted by
‧
國立 政 治 大 學
‧
N a tio na
l C h engchi U ni ve rs it y
legislative body, such as amendment, ratification, and veto powers. In terms of the effects of political systems on international cooperation, Milner argued that we can examine the distribution of legislative power between executive and legislative powers.
Milner concluded that if the executive body enjoys full legislative power, this country is less likely to be sensitive to domestic political factors. In this scenario, the executive will realize international harmonization of the plan it negotiates. On the contrary, when legislative checking power is strong in the legislative process, that country becomes sensitive to domestic actors’ preferences.
If we compare authoritarian regimes with democracies, the former are closer to Milner’s one level game, which the domestic politics do not matter while the latter is subject to domestic political factors. But if we further separate democratic regime into presidential and Westminster and multiparty parliamentarian systems, the executive power in the Westminster system is the greatest which is followed by presidential and multiparty parliamentarian systems (Milner 1997:117-22). This is relevant to bank regulations since the dissemination of Basel Accords require legislative process to adjust the original domestic regulations. Following Milner’s logic, national bank regulations in the countries using Westminster system are more likely to be globally harmonized; multiparty parliamentarian system would comply the least while presidential system locates in between.
Instead of concerning mainly on the effects from executive and legislative power, other research consider bureaucratic preferences important, such as financial regulatory agency or the central bank. David Singer (2007) attributed each country’s international regulatory harmonization to the mechanism of domestic political institutions. In his setting, he assumes that the legislature maximizes a combination of campaign
‧
國立 政 治 大 學
‧
N a tio na
l C h engchi U ni ve rs it y
contributions and aggregate welfare. On the other hand, financial regulators concern with maintaining the autonomy of decision-making in regulating financial affairs. In addition, the decision for the legislature to intervene is based on the public concerns of competitiveness and confidence influenced by the regulations. If financial regulations become too stringent that harms competitiveness of domestic markets, the legislative body will be forced to intervene since private financial sectors, whose political campaign contribution account for a large share for legislators, desire laxer regulations.
On the other hand, should the degree of laxity is too extreme, public confidence in domestic financial market will lower the chances of winning the legislative seats. As a consequence, to avoid intervention from the legislature, regulators’ policy choices will fall into the win-set that satisfies legislative concerns of competitiveness and confidence.
Copelovitch and Singer (2008) found evidence that differences in institutional mandates of the central banks will lead to divergent financial regulations resulting from different concerns. The central banks that are responsible for bank regulation will concern the profitability and stability of the banking sector; therefore, looser financial regulations will be pursued as a result of the sympathy toward banking sectors. On the contrary, if the authority of financial regulations is held by another agency, the central banks will have more incentives to tighten regulations in order to maintain domestic monetary stability. In this research, the authors noticed the underlying incentives provided by the institutional mandates. Last, Tony Porter (2005) found the relevance of domestic institution but proposed a different combination. He recognized the factor of social institutions that included transnational social practices disseminated by international rating companies or associations of international banks.
The above discussion shows that, instead of treating domestic politics as given, a
‧
國立 政 治 大 學
‧
N a tio na
l C h engchi U ni ve rs it y
theoretical framework that recognizes the variation of domestic institutions offer us a more flexible explanation that allows the travelling through time and national borders.
But the question is how well can it be travelled. At least two major flaws result if we rely solely on such approach. The first drawback is that these frameworks seem more applicable to democratic systems which the legislature body at least possesses some power and can be influenced by sectoral lobbies; therefore are more capable of forming influences in the policy-making process of financial regulations. For example, Singer’s theory can be more useful in explicating cases within a country that has stronger separation of powers between the legislative and the executive bodies. But it nevertheless is less ideal to apply his framework in the single-party dominant Singapore where the authority of executive body is so powerful in policy-making process. It would be less likely to use Singer’s framework for examining China where the National People's Congress is, in effect, controlled by the Communist Party of China and only provide informal consultation rather than formal restraint (O'Brien 2008). The second major drawback is that the preferences of regulatory bodies or agencies are fixed, such that the private banking sector will lobby against prudential regulation, or higher CAR, while the public will stand up against banking laxity. Are those assumptions true? Will the occurrence of banking crisis of economic situation change the preference of related groups as I discuss above. For example, the public can be more risk-prone during the period of economic good time but would then become conservative and concern the stability during the crisis. A valid research should be able to account for those exogenous factors.
To sum up, in order to generalize a framework of domestic institution capable of explaining financial regulations worldwide, assumptions regarding the democratic system should be relaxed in pursuit of a strategy to incorporate political phenomenon
‧
國立 政 治 大 學
‧
N a tio na
l C h engchi U ni ve rs it y
existing in non-democracies. The model should also allow longitudinal variation of the preferences of concerned domestic parties or transnational practices.