Incentives for Complexity in Financial Regulation

The incentives of those who are involved in making financial regulation work are important in trying to understand the rapid increase in complexity in the financial supervision framework. As argued in this article, the persons that are engaged in developing regulation, and ensuring compliance with existing rules, have a natural bias towards complex solutions. The drawback is that complexity comes with a substantial negative externality that will reduce our welfare unless properly addressed. The article discusses how this negative externality could be internalized so as to pave the way for an equilibrium in which the degree of complexity is closer to its optimal level than in the overly complex framework that presently is under construction.