05 September 2013

Bundesbank/Dombret: Competition policy and regulation in a global economic order

Speaking in Düsseldorf, Dombret looked at the relationship between competition policy and regulation in the financial sector. "The good news, as far as I'm concerned, is that the path we have taken to regulate the financial sector is the right one", he said.

The political order envisages a clear-cut relationship between state and market: the state creates a setting in which market forces can thrive. Hence, the state’s role in competition policy is to ensure effective competition. It sets the rules of the game but stays off the playing field.

There have always been instances where reality has failed to live up to this ideal. All along, politicians have enjoyed having a stake in the game; the Landesbanken are just one example of this.

But one thing became clear when the crisis began – if not before: the financial sector setting was only partially suited to ensuring a competitive environment that was consistent with market economy principles.

In retrospect, a great deal of trust, probably too much at times, was invested in market forces and market discipline. After the crisis erupted, there was a sharp increase in government interventions to stabilise the financial system. In many countries, banks were propped up by the state or even taken into national ownership.

This government response was motivated, among other things, by a distinctive feature of the financial sector. Relative to other industries, players in the financial sector are very highly interconnected.

This high degree of interconnectedness means that if one participant exits the market, it can potentially bring down others as well. In extremis, this might cause the entire market to collapse and endanger financial stability. What this means, therefore, is that the financial sector is lacking a key aspect of an effective competitive environment – the possibility of businesses exiting the market.

A major financial institution exiting the market can ignite a systemic crisis, leaving the state with little choice but to intervene in order to prevent matters going from bad to worse. And then the taxpayer is left to foot the bill. The no bail-out principle has lost all effect. As Walter Eucken might have put it, those who benefited did not bear the costs.

This very phenomenon has come into play during the crisis. The state no longer merely sets the rules, it has also joined the game, whether by choice or otherwise, because the markets anticipated that it would be forced to intervene in an emergency. Naturally, this no longer fits the ideal of the state envisaged in our political order. If the state wants to get back off the playing field, it will have to adapt the rules of the game. What we need is improved financial sector regulation.

Full speech

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