What would "positive incentives" do for the banking system?

Passage

PASSAGE (Q96–Q100): Read the following passage carefully and answer the questions based on the passage:

"Bank failures raise serious concerns about supervisory oversight." The case studies of Credit Suisse and Silicon Valley Bank highlight the deficiencies in supervisory supervision. In many instances, supervisors are hesitant to come into conflict with bank management when weaknesses are identified, preferring to do nothing rather than take corrective action at a point in time when key issues are building into a problem. Regulators must adopt an attitude change in which they place more emphasis on the results rather than the details. Overemphasis on trivial matters might lead regulators to overlook more fundamental issues, such as whether financial institutions have adequate capital in case of a shock. Regulating requirements must be simplified. Complex regulation requirements in relation to capital may overlook systemic risk in their approaches when stress tests result in activities gravitating towards less heavily regulated institutions in the non-bank sector. Improved supervisory and bank communications would promote better supervision as a tool for managing risk. Recommendations include being up front about supervisory goals, openness to change within the bank organization, and increased transparency in supervisory contracts as a way of promoting swift problem resolution. These would aid shareholders as well as the overall economy. In conclusion, rather than pursuing a micro-management strategy, a move towards a clearly defined regulation that supports positive incentives is what is needed to ensure that banks behave within frameworks that promote financial stability.

Question

What would "positive incentives" do for the banking system?

1. A. Stop banks and regulators from talking to each other often.
2. B. Make bank rules much more complicated and harder to follow.
3. C. Help banks behave in a way that keeps the economy stable. (Correct answer)
4. D. Bring back micro-management and focus on tiny details.

Correct Answer

Option C — Help banks behave in a way that keeps the economy stable.

Detailed Solution & Explanation

The correct answer is Help banks behave prudently of their own accord.

Key Points

• Positive incentives work by making sound behaviour advantageous to the bank, so that prudence follows from self-interest rather than from enforcement.
• The passage presents this as the alternative to detailed supervision, so its intended effect is banks regulating their own conduct within a stable framework.
• The distractors describe the opposite — stopping banks and regulators from acting, making rules more complex, or restoring micro-management.

Additional Information

• Incentive-based regulation aligns the interests of the regulated with the goals of the regulator, which reduces the need for constant monitoring.
• Practical mechanisms include capital requirements that rise with risk-taking, deposit insurance priced by risk, and remuneration rules deferring bonuses.
• The contrast with micro-management is deliberate: incentives set the direction while leaving the institution to determine the detail.
• Where a passage advocates an approach, the correct option usually describes its intended effect rather than its mechanism.