Benefit-Cost Analysis for Financial Regulation

The Dodd-Frank Wall Street Reform Act calls for extensive rule-making for financial regulation, the details of which are left up to the relevant enforcement agencies. To help ensure that this wide discretion is not abused, regulators should be required to use Benefit-Cost Analysis (BCA). While BCA has been used extensively and increasingly in in environmental, health and safety regulation (EHS), as well as antitrust analysis (United States Department of Justice and Federal Trade Commission, 2010), it has little history in financial regulation (Whitehead, 2012). This should not be surprising, given the contrasting literatures in economics on these subjects. The basis of BCA in the former areas was an extensive literature in economics that set a framework for such analysis (Harberger, 1971) and helped clarify key parameters (Viscusi and Aldy, 2003). By contrast, we are not aware of any analogous literature in financial economics. Most work in asset pricing is concerned with informational, rather than allocative, efficiency (whether prices are predictable rather than whether welfare is maximized). Normative work in corporate finance focuses on a relatively narrow set of issues from the perspective of a regulatory authority and on qualitative mechanisms rather than the quantitative tradeoffs at the heart of BCA. In this paper, we make a modest start towards filling this gap. When an agency proposes a regulation, it should compare the compliance costs and the benefits. The former will usually be straightforward to calculate, and so, in each of the first three sections of this paper we examine how three different types of regulatory benefits can be quantified: avoiding systemic crises,