An IMF working paper published this month forced me to rethink the often repeated contrast between the heavy handed rule based US regulatory framework and the light touch principles based system in the UK. The paper New Landscape, New Challenges: Structural Change and Regulation in the U.S. Financial Sector by Ashok Vir Bhatia argues that the US financial sector is divided into a tightly regulated core and a loosely regulated periphery. The tightly regulated core consisting of the banks and depository institutions, the housing sector federal agencies and the big five investment banks today account only for a third of the US financial assets. The remaining two-thirds of the assets are in the periphery which is subject to Bernanke’s “regulation by the invisible hand” of market discipline.
Bhatia argues in particular that “the Fed [serves] a singular role as guardian against more dirigiste temptations.” I think this is an important point – there is little doubt that the US Fed has a significantly lighter touch regulatory mindset than the US SEC. This is also an aspect that is often missed in the simple US versus UK dichotomy of rules versus principles based regulation.
Where the rules based approach is most dominant in the United States is in the area of consumer protection which is of course dominated by the SEC. The UK has shown the way in applying principles based regulation even here and this is a model that is worth emulating. However, the US model shows how great the benefits are of a light touch regulation applied only to the periphery. The vibrancy of the US financial sector is due doubtless to this light touch. For countries like India whose financial sector is repressed by heavy handed regulation, applying light touch to the periphery is a low hanging fruit that can be plucked quite easily and with low risk.