A new ASI volume, What a Capital Idea! How to make Britain’s banks more competitive, innovative, and safer, argues that UK banks that issue high levels of capital should be freed of other cumbersome prudential regulation, such as the mandatory deposit insurance scheme.
John Cochrane, Senior Fellow at Hoover Institution at Stanford University, in his chapter, says:
For as long as there have been banks, there have been recurring banking and financial crises, intermittently spreading economic distress. Rather than solve the problem, the last round of regulation just compounds the tried and failed remedies of previous rounds.
A financial crisis is, at its heart, a bank run. A bank run causes systematic damage when a bank lacks the underlying assets to fund their liabilities, that is, they lack capital. Banks get their money largely from sources that are prone to runs.
The government creates a moral hazard by guaranteeing deposits, this means people do not ensure banks are healthy before depositing money. Banks undertake risky behaviour, which then causes a cycle of crisis requiring large bailouts.
Banks should be more like other businesses, which get their money by selling stocks and long-term bonds, rather than risky liabilities like deposits and very short-term wholesale borrowing.
Banks should be required to issue immense amounts of capital (and long-term debt), so much that their remaining run-prone liabilities are never in question.
The United States’ CHOICE Act offers banks a choice to either continue with the existing system that requires low levels of capital, or if a bank operates with a higher level of capital it can be exempt from swaths of regulation.
Kevin Dowd, Professor of Finance and Economics at Durham University, in his chapter, says:
The history of UK banking prudential regulation is one of repeated failures.
Prudential regulation fails because it is captured by the banks it seeks to regulate and because it presupposes ‘forward-looking’ abilities on the part of regulators that do not exist.
The current UK system of prudential regulation of banking is bound to fail for the same reasons as its predecessors have failed.
The best system is one of high minimum capital standards and strictly unlimited personal liability on the part of senior bankers, and such a system should not be subject to prudential regulation .