Bank Regulation

The application to banks of public controls stricter than those on businesses in general, justified by concerns that bank failures may disrupt the economy more profoundly than other business failures.

Background

Bank regulation refers to the imposition of specific controls and standards on banking institutions, aimed at safeguarding the economic stability and integrity of the financial system. Due to the critical financial intermediaries these institutions perform, their failures can have far-reaching consequences for the economy.

Historical Context

The concept of bank regulation has been rigorously developed particularly since the Great Depression and several financial crises that highlighted the need for stringent oversight to avoid systemic collapse. The establishment of central banks such as the Federal Reserve System in the United States in 1913 was partly to smooth out periodic financial instability.

Definitions and Concepts

Bank regulation involves:

  • Stricter Public Controls: Banks face more rigorous oversight compared to general businesses.
  • Central Bank Supervision: Either the central bank or other designated authority monitors and enforces regulatory standards.
  • Lender of Last Resort: Central banks act to prevent financial distress by providing liquidity to solvent but illiquid banks.
  • Solvency vs Liquidity: Emphasis on maintaining banks’ solvency to ensure that they have enough assets to cover liabilities, even if liquidity needs arise.

Major Analytical Frameworks

Classical Economics

Not heavily concerned with bank regulation, classical theorists rely on market self-regulation.

Neoclassical Economics

Recognizes the necessity for oversight to correct market failures and potential moral hazards.

Keynesian Economics

Advocates for active government intervention, including rigorous bank regulation, to maintain economic stability.

Marxian Economics

Critiques regulations as insufficient measures that fail to address the systemic issues within capitalist banking.

Institutional Economics

Focuses on the role of regulatory institutions in shaping banking behaviors and market outcomes.

Behavioral Economics

Explores how cognitive biases among bank management and consumers can justify the need for strong regulatory frameworks.

Post-Keynesian Economics

Emphasizes the importance of financial stability to overall economic health and argues for robust, adaptive regulation.

Austrian Economics

Views regulation skeptically, asserting that market self-correction should prevail and that regulatory overreach often exacerbates financial problems.

Development Economics

Considers the regulatory framework crucial in support of developing formal financial systems, fostering inclusive growth.

Monetarism

Supports limited but strict regulation to ensure that banks do not destabilize the money supply framework.

Comparative Analysis

Comparative analysis of countries with different regulatory frameworks shows the variance in economic stability, market confidence, and incidence of financial crises due to the efficacy of bank regulation.

Case Studies

  • The Great Depression (1930s): Lack of regulation led to widespread bank failures.
  • The 2008 Financial Crisis: Highlighted the significance of stringent oversight on institutions deemed “too big to fail.”

Suggested Books for Further Studies

  1. “Manias, Panics, and Crashes: A History of Financial Crises” by Charles P. Kindleberger and Robert Z. Aliber
  2. “The Alchemists: Three Central Bankers and a World on Fire” by Neil Irwin
  3. “The Regulation of International Banking” by A.W. Mullineux
  • Basel Agreement: International regulatory framework intending to strengthen regulation, supervision, and risk management within the banking sector.
  • Capital Adequacy Ratio (CAR): A measure of a bank’s available capital expressed as a percentage of its risk-weighted credit exposures.
  • Liquidity Coverage Ratio (LCR): A requirement for banks to hold enough high-quality liquid assets to cover their total net cash outflows over 30 days.
Wednesday, July 31, 2024