The evolving complexity of capital regulation

Regulatory complexity imposes heavy deadweight economic costs and undermines efforts to strengthen financial stability. Nonetheless, the problem has received virtually no attention in the wave of regulatory reform that swept around the world in the wake of the financial crisis of 2007-2009. Indeed, most of the reforms have increased regulatory complexity. This article attempts to sketch the broad outlines of the problem that I hope will receive much broader attention. The first section illustrates how complexity undermined financial stability before the crisis. The example illustrates how complexity in financial instruments, complexity in financial regulation, complexity in financial institutions and complexity in bankruptcy and resolution procedures combined to exacerbate financial vulnerability. The second section argues that regulatory reform has generally exacerbated regulatory complexity, using the reform of capital regulation as the primary example. The final section is much more speculative and considers why regulatory simplification remains so elusive.

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