Sunday, June 7, 2015

How to Fix the Banks: Revisited

The bankers are angry. They feel the regulations designed to prevent another meltdown are cramping their style. Their bonuses are down. I agree. Red tape is not the way to save the banking system.

The banks engaged in a freewheeling orgy of unregulated risk taking for two decades. And when the world crashed: they expected, and received, bailouts. But we don't need to bash the banks to save the system.

As a society, we do not have a stake in saving HSBC. We do not have a stake in saving Barclays, or RSBC, or Lehmann Brothers, or Bank of America. But we do have a stake in saving the banking system. Here is a link to a piece I wrote in 2009 on how to do that.


  1. To what degree is your argument premised on the idea that new bank formation is possible? One of the most worrisome aspects of the aftermath of the crisis was that the barriers to new bank formation were apparently increased by regulators in late 2008 -- just when one would have expected new entrants to be very successful by coming in without all the baggage of bad assets on their balance sheets.

    The number of new banks formed dropped from about 125 per year per-crisis to almost none post-crisis. See this American Banker article from 2013 which includes this passage:

    "Many attorneys and consultants feel the FDIC has been discouraging the formation of new banks since late 2008, preferring that investors plow money into existing institutions that need capital to survive. In 2009, the agency tightened oversight of startups, which have been rare in the years since. The country's last new bank, the $39 million-asset Start Community Bank in New Haven, Conn., opened in the fourth quarter of 2010.

    ""I've had groups communicate with me about the possibility of forming a de novo bank in the traditional model, and I have at this point been discouraging them from pursuing it, just because the time frame and the regulatory hurdles are so severe," says James Rockett, a lawyer with Bingham McCutchen in San Francisco.

    "Even if regulators become more open to de novos, the application process is unquestionably longer and more difficult than it was before the financial crisis, according to attorneys and consultants who advise bank organizers.

    ""It's a literal minefield right now trying to figure out what they want," says Charles Ingram"

  2. Carolyn
    I'm in favor of minimal regulations on banks. When regulations exist, the reasons for those regulations should be clear and transparent. There are many such reasons.

    First: There are inherent tendencies towards a monopoly banking system that arise from decreasing marginal costs. That, in my view, is a reason to break up large banks and encourage the formation of new banks.

    Second: Deposit insurance, and implicit bailout guarantees, provides an incentive to risk taking and creates moral hazard. The scheme discussed in my FT piece provides a credible way to insure the banking system (recognized as an important function of a central bank since the work of Bagheot) without generating moral hazard for individuals banks. We should be prepared to bail out the banking system. We should not be prepared to bail out individual banks.

  3. Maybe a good way to promote your view is to point out that, if the government supports an index, it can avoid creating the incentives to support incumbents (and to prevent entry that could undermine the funding of existing banks post-crisis) that exist with the current deposit insurance scheme.

  4. Central bank issuance of emoney would be key in fixing banks. Banks would have to pay more interest on deposits regulating issuance by banks as they lend. Banks which are most transparent and well managed would attract more deposits.


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