Cost-Benefit Analysis in Rulemaking and Financial Regulators

Cost-Benefit Analysis in Rulemaking and Financial Regulators

Many regulatory agencies are required—by statue or executive order—to perform regulatory analysis assessing the potential effects of a proposed regulation prior to implementing it. For many federal agencies, this analysis must include a cost-benefit analysis (CBA)—a systematic and sometimes quantified examination of all potential economic costs and benefits resulting from the implementation of a proposed rule. However, the required scope and level of detail of regulatory analysis can vary between different departments and agencies, particularly for financial regulators. Financial regulators generally face requirements that involve a relatively narrow analysis of specific effects or that leave the parameters of a CBA to the discretion of the agency. Some observers assert that financial regulators should be required to do more extensive regulatory analysis that includes a CBA, and legislation has been proposed that would increase requirements on these agencies. Examples of bills that have been introduced in the 114th Congress include those that would affect only one financial regulator (H.R. 5429), bills that would affect many financial regulators (H.R. 5983), and bills that would affect all agencies, including the financial regulators (H.R. 185). This Insight examines the issues surrounding CBA, especially as it relates to these agencies.

Current Requirements

Executive Order (EO) 12866 and Office of Management (OMB) Circular A-4 direct the analysis done by many federal regulators. EO 12866 requires covered agencies to adhere to certain principles for regulatory analysis and establishes a review process—performed by OMB's Office of Information and Regulatory Affairs (OIRA)—to ensure adherence to those principles. The principles require that a regulation only be adopted "upon a reasoned determination" that the benefits justify the costs, while recognizing that "some costs and benefits are difficult to quantify" and directing "each agency to base its decisions on the best reasonably obtainable ... information." Circular A-4 provides guidance to covered regulators regarding EO 12866 and establishes best practices.

Because financial regulators are generally classified as independent regulatory agencies, many are exempt from EO 12866 requirements. They are subject to other requirements to assess the effects of their rules, and these generally require a relatively narrow analysis or allow for agency discretion in what is included in a broader CBA. For a more detailed examination of these requirements, see CRS Report R42821, Independent Regulatory Agencies, Cost-Benefit Analysis, and Presidential Review of Regulations.

Purpose and Potential Limitations of CBA

Cost-benefit analysis helps ensure that regulators are held accountable during the development, issuance, and implementation of rules, by demonstrating that their decisions are based on an informed estimation of likely consequences. Ideally, all societal costs and benefits of any new rule could be accurately and precisely estimated, quantified, and monetized. Proposed rules would be finalized and implemented only if benefits were expected to exceed costs. Unfortunately, analysis containing this degree of quantitative precision is often not feasible. Predicting future outcomes requires making assumptions that are subject to a degree of uncertainty. Accounting for human behavioral responses to a regulation poses challenges. Some effects are difficult to quantify and monetize. Relevant data are not always available and accurate.

This raises questions about the appropriate scope, level of detail, and degree of quantification that should be required of the analysis performed in the rulemaking process. Overly lenient requirements could risk overly burdensome regulation with limited benefit being implemented by an unaccountable agency without due consideration of consequences. Overly onerous analytic requirements could risk impeding the implementation of necessary, beneficial regulation because performing the analysis would be too time-consuming, too costly, or simply not possible.

Expanding Requirements on Financial Regulators

Whether financial regulators should be required to perform more detailed and quantitative CBA is the subject of long-standing debate—possibly due at least in part to their exemption from the EO 12866. Also, the matter has attracted increased attention as many financial regulations have been implemented in response to the financial crisis.

Some observers assert financial regulators should not be subject to rigid legal structure when performing CBA—especially because of the difficulties of quantification. They claim that attempts to quantify the effects of financial regulation are imprecise and unreliable. These attempts entail making causal assumptions that are contestable and uncertain, and often face issues concerning data availability and accuracy. In addition, financial regulation aims to induce behavioral, microeconomic, and macroeconomic responses, and these effects are harder to quantify than regulations in other industries that lead to more measurable effects. For example, if certain factories were required to install a piece of equipment that prevented the release of a pollutant, the cost of the equipment is identifiable and the direct effect of how much of the pollutant would be captured can likely be measured. In contrast, if a requirement is implemented on banks to hold more liquid assets, the cost to banks is uncertain because it depends on what types of assets banks choose to shed from their balance sheets, what they add, and what effect those actions have on the market prices of those assets. It is also unclear how to quantifiably measure the "liquidity" of the financial system or its resultant benefits.

Others assert that financial regulators should be subject to stricter CBA requirements than is currently the case. They argue that requisite, quantitative CBA—even in the case of financial regulation when it might yield a wide range of estimates or disagreements over accuracy between technical experts—is necessary because it disciplines agencies in regard to what rules they implement, allows for an objective assessment of whether a regulation is desirable, and achieves its objective at the least possible cost. Some claim that the challenges of performing CBA for financial regulations are not greater than for other industries, arguing that the necessary data are available and estimations of benefits and costs—while challenging—are possible. In addition, some observers have proposed methods of analysis to improve the quality of assessment of new financial rules.