TITLE:
Kautilya on Foresight, Oversight, Regulations, Ethics and Systemic Risk
AUTHORS:
Balbir S. Sihag
KEYWORDS:
Ethical Grounding, Foresight, Oversight, Moral Hazard, Moral Failure, “Too-Big-to-Fail”, Systemic Risk
JOURNAL NAME:
Theoretical Economics Letters,
Vol.7 No.3,
March
22,
2017
ABSTRACT: In the wake of the recent Great recession of 2008-9,
prudential supervision and “too-big-to-fail” have become the focal topics of
discussion and policy. Western countries have added prudential supervision to
complement the traditional regulatory approach to prevent reoccurrence of
financial crisis. Additionally, large financial institutions are subjected to
repeated “stress tests” to diagnose the vulnerability of the financial system.
Kautilya had argued a long time ago that moral failure was the primary source
of the systemic risk. Keeping that in view, relevance of his three insights is
presented. Firstly, regulations, prudential supervision and ethical grounding
are needed for preventing future financial crisis. That is, current approach of
relying only on regulations and supervision, most probably would not prevent
future financial crisis. Secondly, if moral hazard resulting from moral failure
is the primary source of systemic risk, undue focus on “too-big-to-fail”
financial institutions is unwarranted. Thirdly, Financial Stability Oversight
Council’s two objectives, promoting market discipline and prevention of another
financial crisis, do not seem to be compatible with each other.