Banking and Financial Regulation

This chapter provides a basic overview of banking and financial regulation for the forthcoming Oxford Handbook of Law and Economics (Francesco Parisi, ed.). Among other things, the chapter compares traditional and shadow banking and their regulation, differentiating “microprudential” regulation (which focuses on protecting individual components of the financial system, such as banks) and “macroprudential” regulation (which focuses on protecting against systemic risk). The chapter also examines how regulation can help to correct market failures that undermine financial efficiency. In that context, it discusses, among other things, capital requirements, ring-fencing, and stress testing. Finally, the chapter examines how regulation can help to protect against systemic risk, including by addressing potential triggers of systemic risk (such as maturity transformation — the asset-liability mismatch that results from the short-term funding of long-term projects — and limited liability).