Navigating the Competition-Stability Nexus in Financial Services: A Dynamic Extension of the Tinbergen Rule

Pietro Calice

No 11124, Policy Research Working Paper Series from The World Bank

Abstract: This paper extends the classic Tinbergen rule within the context of financial regulation, explicitly accounting for the inverted U-shaped relationship between market competition and financial stability. Conventional policy frameworks, premised on independent relationships between policy targets and instruments, inadequately address the complex interactions inherent in the competition-stability nexus. The proposed framework addresses this gap by incorporating four critical dimensions overlooked in traditional applications of the Tinbergen rule: (i) nonlinear interactions among policy objectives, (ii) conflicts arising at extremes of competition, (iii) a hierarchical prioritization of financial stability objectives, and (iv) inherent structural constraints of prudential instruments. The paper introduces a dynamic optimization approach that calibrates policy instruments according to the financial system’s position along the competition-stability curve. Additionally, it provides a comprehensive taxonomy of regulatory instruments, categorizing them based on their primary targets and secondary (cross-) effects, thereby facilitating state-dependent policy formulation. The paper also outlines practical institutional arrangements and coordination mechanisms that are crucial for effective implementation. Overall, the approach may help to equip regulators with strategies for dynamically managing competition and stab ility, ultimately enhancing the efficiency and robustness of financial systems.

Date: 2025-05-19
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