Considering Public Interest Regulatory Theory : Investigating the Links between Regulatory Emphasis and Effectiveness

This article explores the linkages between public-interest and regulatory theory. By examining academic scholarship relating to effectiveness and regulatory theory, this article proposes that there are links between agencies with a public-interest orientation and effective regulatory action. In order to examine this relationship this article analyzes three federal financial services regulators and their varying levels of effectiveness. In order to do this analysis focuses on three types of regulatory actions. These are technical, clientele, and public interest interventions. Next, the article looks for linkages among variations in regulatory style and agency effectiveness (in these cases as measured by regulatory ability to prevent the failures of supervised institutions). The analysis concludes by stating that there does appear to be some evidence for linkage between an agency's public interest orientation and their ability to effectively supervise a regulated community.


Introduction
Regulators have varying ways that they relate to the communities they supervise.Different regulators and policy areas also have varying administrative tools that allow them to influence the behavior of those they police.These strategies or points of regulatory emphasis can drastically change agencies orientations towards those they are tasked with supervising.Yet, there has been little research, both theoretical and applied that investigates the specific dynamics of regulatory orientation and effectiveness (Aberbach, 1990;Bernstein, 1955;Eisner, 2000;Katzmann, 1980;Meier, 1985).
This article theorizes about and explores the impact of agency orientation towards supervisory community on regulatory effectiveness.I start by proposing that regulators more inclined to focus on engaging in public interest and technical policymaking rather than empowering their regulated community are more effective at policing behavior (Katzmann, 1980).By focusing on technical and public interest issues agencies avoid captured relationships with their supervised institutions.Furthermore, by engaging in dialogue that reflects public interest values, rather than the values of their regulated communities, regulators can gain perspective allowing them to balance the concerns of their supervisory institution with those of the public (Goodsell, 1990).
The focus on public values by regulators may better allow them to separate the narrow interests of the regulated community (in this analysis clientele interests), from the broader systemic understanding of the role of regulators (in this project referred to as public interest).However, this task can be challenging.Many regulators are structured with ambiguous mandates from Congress (Aberbach, 1990).Furthermore, gauging the effectiveness of regulatory agencies is also fraught with peril.Agencies exist in complex policy environments and have many expectations from both public and private sector actors that seldom agree what precisely their role should be.Nevertheless, there are some regulatory contexts where one can isolate and investigate public interest, clientele interests and tie that to a broader understanding of agency effectiveness (Baumgartner & Jones, 2005;Feldmann, 2005;Goodsell, 1990).
At least in part, this analysis hinges on an understanding of regulatory effectiveness among financial services regulators that primarily focuses on preventing systemic risk.The term systemic risk is essential to understanding the development of financial services regulators.Kaufman and Scott (2003)  The relationships theorized above in Figure 2 relates to level of effectiveness and the type of regulatory interventions that agencies undertake.I theorize that more effective agencies engage in public interest and technical types of policy communications and interventions more frequently than clientele oriented policies.While all regulatory agencies engage in varying levels in all three types of policies those that are most effective at supervising regulated communities focus less on empowering their supervised institutions and more on giving technical guidance or constraining regulated entities behavior through formal and informal policy processes.
Essentially, I argue that there is a linear relationship among regulatory and effectiveness.The least effective regulators focus on clientele issues and most effective focus on public interest.While regulators of moderate effectiveness focus on technical issues (however there are debatable amount of overlap between technical guidance and clientele and public interest emphases).This expectation is drawn from a variety of research that focuses on the nature of regulatory capture specifically among financial services institutions (Boehm, 2007;Hardy, 2006;Laffont, 1991;Smyth, 2009;Thomas, Soule, & Davis, 2010;Woodward, 1998)and the failures within government that have led to previous banking crises (Moe, 1991;Buiter, 2008;Johnson, 2010;States, 2011;Whalen, 2008).
This analysis proposes a classification of types of policy statements.It is based on the distinction drawn by regulatory capture theorists that a captured system exists for the benefit of a clientele group and not for the public interest.Therefore, testimonies, speeches, informal rulemaking, and formal rulemakings are classified for the purpose of understanding the client groups to which policies are aimed.The three classifications are clientele, the public interest, and technical statements.This analysis treats capture as a subset of overall agency behavior.Rather than simplistically viewing capture, it contends that agencies move in and out of captured relationships based on legislative attention.

Clientele Policies
Clientele policies are narrowly tailored directly toward the regulated community.In this study that would represent national banks for the OCC, thrift institution for the OTS, and federally insured credit union for the NCUA.Clientele policy is tailored to directly benefit the regulated community in an obvious way.Referring back to the agency theory that underpins the relationship between the actors within the policy environment, clientele policy represents a very low degree of goal differentiation and information asymmetry between the regulator and regulated institutions.This is because the regulators frequently act as an expressed advocate for its regulated institutions.
The most common examples of a clientele policy are attempts at regulatory relief which lessen the regulatory burden on regulated institutions.Other types of clientele policy are statements aimed at establishing the importance of the regulated industry and statements geared towards expansion of business powers for regulated institutions.Within the financial services regulatory environment which has self-funded regulators pushes toward efficiency at expense of effectiveness and equity also fit this criteria.

Public Interest Policies
Public interest policy is distinguished by pertaining to more general and consumer oriented issues.Frequently these policies are espoused by regulators acting in a policing role.Furthermore, these policies would not be championed by most of the regulated institutions.Agency theory as applied to public interest policy would have a high level of goal differentiation and a high level of information asymmetry.This is because public interest policies focus on consumer issues and systemic risk that interest group advocacy efforts do not focus on.Examples of public interest policy would be a regulator making statements regarding predatory lending, financial literacy, or the safety and soundness of the financial system.While public interest policy may closely mirror cleverly disguised clientele policy, the distinction between the two generally rests in the constituency at which the policy is aimed.
Policies aimed at the general public and not financial institutions employees will generally be public interest oriented.

Technical Policies
Technical policies are statements from the regulator to the regulated community of a technical nature.Generally these statements deal with sophisticated guidance relating to compliance issues.While many technical policy issues may in fact be cleverly disguised clientele policies also, the distinction lies in the audience.Agency theory posits that technical policymaking by regulatory agencies would generally have a high level of information asymmetry and a low-level of goal differentiation.Generally these policymaking are aimed at technical forms of guidance clarifying and crafting policy issues that the regulated institution in good faith has attempted to comply with.An example of technical policymaking would be accounting rules and guidance relating to internal controls or the manner which capital should be counted by call reports.
In recent years there has become less difference between the powers granted by different financial services charters.Historical differences in power, capital requirements, and lending limit between federally and state-chartered institution have converged.Therefore, the remaining divergence relates to federal preemption and the lower supervisory costs of state-chartered regulators (Blair & Kushneider, 2006).
During the last two decades, all financials services regulators have focused on reducing the costs of supervision.
Regulators attempted to reduce the cost of supervision.They reduced assessment fees and prevented the indexing of the assessment schedule for inflation.The agency also put in place a minimum supervisory fee for small institutions.The authors argued that the agency shifted the funding of the agency from a larger institution to the smaller ones.This placed a substantial burden on smaller institutions to fund the OCC's activities (Blair & Kushneider, 2006).Several scholars have argued that the main dynamic influencing charter choice are the broadest range of powers offered at the lowest regulatory cost (Estache, 1999;Martimort, 1999).The focus on parity among regulated institutions and cost-effectiveness has at least in part been coordinated by interest groups seeking to lobby financial services regulators.The interest groups that lobby financial services regulatory agencies are some of the best funded associations at the federal level.This greatly complicates the ability of the OCC, OTS, and NCUA to engage in public interest policymaking (Hammond & Knott, 1988;Hoffmann, 2001, Hammond, 1957).

Interest Group Context
Each regulator has a group or groups that attempt to influence their policy.The OCC interacts most frequently with American Bankers Association and Independent Community Bankers of America.The OTS primarily caters to America's Community Bankers which recently merged with American Bankers Association.The NCUA interacts with the National Association of Federally Chartered Credit Unions and the Credit Union National Association.CUNA represents state-chartered credit unions and their primary interactions with NCUA are regarding the insurance fund.

Charter Strategies
The agencies that are the subject of this study each operate in a manner that allows them to accentuate the benefits of their charter and deemphasize the weaknesses.The NCUA offers the institutions it regulates the considerable advantage of the federal corporate tax exemption.However these institutions do not have access or have only limited access to the capital markets and therefore may only be funded to very conservative means.Furthermore, federal credit unions have a cap on the amount of business lending they are permitted to engage in, currently 12.25 percent of total assets.While historically NCUA has not focused on enforcing the business lending cap, it has also lobbied for institutions it regulates to have expanded business lending powers.
In many ways the OTS is caught between the true mutuality of federal credit union charter and the efficiency of the commercial bank charter.This has led to the regulator and thrift-oriented advocacy groups to push for measures that allow them to better compete with both commercial banks and federally chartered credit unions.Thrifts are subject to the "Qualified Thrift Lender Test (OTS 2010)."The test requires thrifts to keep proximately 80 percent of their assets in mortgage-oriented types of instrument.The focus on mortgage lending greatly reduces OTS regulated institutions' ability to take part in business lending but in theory should make them less likely to fail.
In order to aid thrifts competing against credit unions, the OTS has been an advocate of the subchapter S tax structure for institutions.Subchapter S allows institution to be taxed at the shareholder rather than the corporate level.However, there are strict requirements regarding the number of shareholders allowable.Attempts such as this to decrease the tax burden on OTS-regulated institutions are a curious leveler to the credit union advantage of a corporate tax exemption.
Even stranger than Subchapter S status is the mutual holding company structure.This allows mutually owned banks to offer a minority stock offering of up to 49 percent of the total capital in order to raise funds.However the majority ownership still exists as a mutual structure.Congress developed the mutual holding structure to allow mutual banks to compete with commercial banks' ability to raise capital through an initial public offering.
The OCC has been successful competing with the OTS and NCUA.Subchapter S status which is also available to national banks levels the playing field with federal credit unions.As stated previously the OCC regulated institutions generally have access to capital through stock offerings.National banks have the broadest range of powers.In recent history, OTS and NCUA regulated institutions have been forced to play catch-up with the broad granting of power to national banks.In fact the analysis of policy statements by the OCC showed the agency's preoccupation with preserving the preemption of federal bank regulators over state law (Hoffmann, 2001).
define systemic risk as: compliance, and clientele interests (see Figure2).