Does bank regulation help to avoid bank failures? If anyone should know about it, people in Japan should, given their experience of financial turmoil in the 1990s. And at a conference here in Tokyo, Professor Yoshinori Shimizu of Hitotsubashi University has produced some evidence that markets are a better guide and guardian than regulators.
It does not seem, for example, that the Bank for International Settlements' capital regulations really improve banks' soundness. The so-called Basel rules place restrictions over banks' assets to make sure they don't get too shaky. But political horse-trading allowed different countries to adjust the rules to suit themselves. Japan decided that its banks could include notional profits on shares and land, which was fine until the stock and property markets started to slide and the notional assets turned into liabilities.
So the regulation was in reality making the financial markets riskier. On the BIS ratios the banks looked fine, but in reality their assets were becoming worthless. The BIS capital ratio for Hokkaido Takushoku Bank didn't fluctuate much, around 9%, between 1993 and 1997, but it still went bust. By contrast, says Professor Shimizu, the market valuation of the bank's capital plummeted. And a similar story unfolds for many other banks as well.
If you want to know whether banks are making bad loans, it seems, you are better to look at how the market views that bank's business, rather than some regulator's yardstick. Regulation makes investors feel comfortable, when they should be looking very critically at the businesses they trade with. We should have less.
