Financial regulatory institutions are at the center of intense debates over how to supervise financial firms and markets. They are also the focus of an important and growing body of literature that is mainly concerned with the question, “Who should regulate the regulators.” Financial regulatory institutions are usually audited as part of the review of a particular country by international organizations such as the International Monetary Fund, the World Bank, or the OECD. In practice, this means that the structure of financial regulatory institutions and the conduct of financial regulators are not regularly and consistently monitored.

In our recent paper, we argue that the debate should include not just who should regulate the regulators, but also how they should be regulated. We examine how the principles of corporate governance address conflicts of interests between shareholders and other stakeholders in corporations, and apply those principles, with necessary adjustments, to financial regulatory institutions. We believe that this would solve many of the problems with monitoring financial regulatory institutions and holding them accountable.

While private-sector companies differ from financial regulatory institutions, there are also similarities. In our paper, we discuss the general differences between private- and public-sector institutions, present arguments supporting the existence of similarities, and, finally, show which standards of good corporate governance should also be applied to financial regulatory institutions.

First, independence is critical to regulators’ ability to make professional decisions that serve the public interest, free of political influence. Being dependent on politicians for budgetary approval or other needs might interfere with the regulators’ strategic, long-term thinking, and force them to work under short-term political constraints. We recommend making the regulators financially independent, with budgets defined by the regulatory institution and funded through fees levied on the regulated industry.

Second, to improve monitoring of a regulatory authority and its work, we recommend that it create an audit committee. In addition, if it gains independence over its budget, we also recommend that it appoint a compensation committee to set remuneration for top executives. Our other recommendations include peer review of the work of the regulatory institution by counterparts from other jurisdictions, and a duty of care for members of the board of directors.

Overall, our main normative suggestions are: (i) to reduce the number of financial regulatory institutions in any single jurisdiction, (ii) to free the board of the regulatory body from political intervention by, for example, prohibiting the appointment of politicians to the board, (iii) to make the budget of the regulatory body completely independent from government, in how it is funded and determined, (iv) to make it easier for regulators to retire early with full benefits and perhaps a substantial payment so they can regulate during crises without fear of retribution, (v) to diversify the board of directors of the regulatory institution by including mandatory public representatives and experts, (vi) to impose a statutory duty of loyalty and care on the directors of the regulatory institution and the regulator himself or herself, (vii) to appoint audit and remuneration committees, (viii) to institute mandatory peer review by counterparts from other jurisdictions, (ix) to restrict the service of former employees of the financial regulatory institution as external consultants to the regulatory authority in order to avoid capture and conflict of interests, (x) to clearly set out by law the goals of the financial regulatory authority, and (xi) to require extensive public disclosure of the regulatory work.

We believe that implementing these recommendations could help solve some of the accountability and conflict-of-interest problems of financial regulatory institutions and improve the quality of their financial supervision and regulation.

This post comes to us from Hadar Jabotinsky, a postdoctoral fellow at Hebrew University of Jerusalem, Israel, and Mathias Siems, a professor of commercial law at Durham University, UK. It is based on their recent paper, “How to Regulate the Regulators: Applying Principles of Good Corporate Governance to Financial Regulatory Institutions,” available here.