Risk of regulatory failure of “risk-based regulation” while using enterprise risk management as a meta-regulatory toolkit

Mohammad Moniruzzaman

doi:10.1108/ajeb-05-2021-0067

Abstract

PurposeDebate is growing around the expansion of risk-based regulation. The regulation scholarship provides evidence of regulatory failure of the risk-based approach in different domains, including financial regulation. Therefore, this paper aims to provide cautionary evidence about the risk of regulatory failure of risk-based strategy in the financial regulation while using enterprise risk management (ERM) as a meta-regulatory toolkit.Design/methodology/approachBased on interview data gathered from 30 risk managers of banks and five regulatory personnel, combined with secondary data, this study mainly explores the challenges for meaningful use of ERM based self-regulation in regulated banks. The evidence helps to assess the risk of regulatory failure of the risk-based regulation while using ERM.FindingsThe evidence reflects that regulated banks face diverse challenges arising from both peripheral and internal environments that limit the true internalization of ERM-based self-regulation. Despite this, the regulator uses this self-regulation as a meta-regulatory toolkit under the risk-based regulation to achieve the regulatory aims. However, the lack of true internalization of ERM based self-regulation is likely to raise the risk of regulatory failure of risk-based regulation to achieve the regulatory goals. Risk-based regulation is an evolving strategy in the regulatory regime. Therefore, care should be taken while using ERM as a regulatory toolkit before relying on it substantially.Originality/valueThe paper provides empirical insights about the challenges for effective use of ERM as a meta regulatory toolkit that might be useful practically both to the regulators and regulated firms.

Highlights

The notion of “risk” has gained much prominence among the regulators in policy reform in diverse areas, including financial regulation (Ojo, 2010)
Based on interview analysis with risk managers and regulator, combined with secondary data, this study has explored the practical challenges of meaningful use of enterprise risk management (ERM) based self-regulation in the regulated banks in the financial industry
These practical challenges help to assess the likelihood of the regulatory failure of risk-based regulation because regulators substantially rely on such ERM based self-regulation under a metaregulatory approach to regulate the regulated firms

Summary

Introduction

The notion of “risk” has gained much prominence among the regulators in policy reform in diverse areas, including financial regulation (Ojo, 2010) It is considered the principal doctrine for “better regulation” (Black and Baldwin, 2010). Riskbased regulation is a philosophy that enables regulators to govern by “risk” and provides a powerful rationale to achieve the regulatory objectives in a legitimate way (Beaussier et al, 2016) It is emerged as a “flexible regulation” alternative to the “command and control” regulation (Ford, 2017; Coglianese, 2020). It is regarded as a governance technique in the “New Governance” scholarship (Black, 2012). This strategy is much favored to the regulators for its flexibility and responsiveness across the globe, including the UK, Australia,

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