Adam Smith Institute

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How to regulate banks

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how-to-regulate-banks

No cowboy jokes at Dave Davis MP's talk on banking regulation at Civitas today, but a lot of ideas on what to do about our brokeback financial system.

Much of the problem, says DD, came from the authorities' desperate attempts to avoid every crisis – so there were none of the smaller 'forest fires' that would have eliminated over-risky or inept practices. Then there was the implicit government guarantee, which allowed banks to take on massive risks, reward themselves handsomely when it paid off, and leave taxpayers holding the baby when it didn't. Regulators had the power to curb the banks' risks, but they didn't. And they let banks publish utterly opaque accounts that didn't reveal how many risks they were taking, or how highly interlinked they all were.

As for solutions, well, gratuitous new regulation of the Dodd-Frank Bill sort will just add to costs without curing the problem. We need to make it easier for banks to fail – as they do all the time in the US, usually opening up under different ownership a few days later, with depositors' funds protected through insurance. We need living wills, says DD, but ones that make it both public and very clear which assets are protected and not protected in the event of problems. We need a more aggressive competition policy, he thinks, and to separate retail and investment businesses.

I may not be a banking expert – I put my money into IceSave – but the solutions seem clear to me. Bring market principles back into banking. Don't regulate with FSA tick-boxes, which just raise costs and so reduce competition. Regulate with chunky reserve requirements and forget the rest. Have even chunkier requirements on the bigger institutions which pose the biggest systemic risk. Don't try to legislate the structure of banks, but make them tell their customers how safe, or otherwise, their money is. And let's have sound money, so politicians can't get us into the same boom-bust cycles again. Job done.