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Kaufmann et al. (2002: 10) define public sector governance as "the traditions and institutions that determine how authority is exercised in a particular country. This includes (1) the process by which governments are selected, held accountable, monitored, and replaced; (2) the capacity of governments to manage resources efficiently and to formulate, implement, and enforce sound policies and regulations; and (3) the respect of citizens and the state for the institutions that govern economic and social interactions among them." This definition is, by extension, also applicable to appointed bureaucracies and official agents, including financial sector regulators. Regulatory governance, which is a more specific concept, refers to the efficient and effective application of governance in the area of regulation. (Ferris, 2001). It encompasses the whole system by which regulation and competition are managed to achieve societal goals. (Cariño, 2002).

Das and Quintyn (2002) use the term regulatory governance to refer to “institutions that possess legal powers to regulate, supervise and/or intervene in the financial sector” (p. 7).

They argue that good regulatory governance in the financial system is a critical component of financial stability. It is needed to promote effective competition in the companies being regulated, as well as facilitate the on-going process of change and provide the public with an efficient supply of services at reasonable prices. By failing to apply good governance principles, regulatory agencies lose credibility and moral authority to promulgate good practices in the institution under their oversight. This could create a moral hazard problem, contribute to unsound practices in the markets, and, ultimately, accentuate crises in the financial system. And a key aspect is that sound governance practices are also established and practiced by the regulatory agencies themselves. In fact, most of the financial crises of the past decade involved political interference in the regulatory and supervisory process, forbearance, and weak regulations and supervision. All these are symptoms of weak regulatory governance.

According to Das and Quintyn, good regulatory governance has four components— independence, accountability, transparency and integrity. Independence relates to independence from the political sphere and from the supervised entities. The issue has been raised as to why politicians would choose to delegate tasks related to economic and social regulation to an independent agency, rather than to a government agency, a specific ministry, or a local body. Das and Quintyn note two advantages of the former over the latter: expertise can be resorted to and relied on, especially when complex situations arise; and to safeguard market intervention from political interference, which would improve the transparency and stability of the outcome. That is, the possibility of making credible policy commitments would be enhanced by agency independence.

Credible policy commitments also have to do with the time-inconsistency problem. That is, political executives find it very difficult to credibly commit to long-term strategies and solutions due to the short-term cycles of elections and term limits. Another commitment problem that they are faced with is that they cannot bind a subsequent legislature and government. This makes public policies vulnerable to reneging, and would therefore lead to a lack of credibility (Majone, 1997; in Das and Quintyn, 2002).

However, the need for political independence has also raised concerns that independent agencies would be outside political control, not be politically accountable, or pursue their own agendas that may go against the agenda of the political majority in democratic regimes.

Independent regulators have sometimes been referred to as the “fourth branch of government,” implying that they are outside the control of the traditional three branches that, through checks and balances, keep mature democratic systems in equilibrium. Such concerns are deemed as justified. Thus, it is also argued that independence should go hand in hand with accountability, particularly with respect to delegating authority (the government or the legislature), to those who fall under their functional realm, and to the general public. In practice, though, implementing it is more complex. If the agency’s objective is clearly defined 35