Sunday, December 14, 2008

From Regulation Failure to Non-Regulation of Banks

Regulation of banks was never before based on such a sophisticated system as during the past 20 years, from the solvency rules of Basel I and Basel II to internal risk-metrics of individual banks. Yet we have seen banks gone bust as for centuries earlier. Also, there is nothing new in bailing out banks with taxpayers’ money.

Sveriges Riksbank, today’s central bank of Sweden, was in huge difficulties in the mid-1760s after having during the so-called Freedom Era extended credit to the merchants of Stockholm the most of which had gone sour. The difficulties were preceded by years of rapid inflation, credit growth and money printing. But, because the bank operated under the guarantee of the Parliament (Sweden had a parliamentary system at that time) it was of course gradually rescued by the taxpayers’ money. The years were politically stormy, two main parties competing for power. But in the end, a “third party” - the king party - won so that King Gustav III could again re-establish an authoritarian kingdom in a bloodless revolution in 1772.

Today the Federal system has assumed functions that traditionally do not belong to a central bank. It has purchased commercial paper issued by big US companies, for example. So the next “too-big-to-fail” institution may be the Fed; Obama’s Court, please be beware of! The situation in Britain and Ireland may essentially not be very different from the US quandary.

After regulation failure of the current scale, a tighter regulation hardly is the course to be followed as pointed out by immediate popular comments; tighter controls would not have prevented East Germany from collapse because German Democratic Republic did not exist.

If effective regulation of banks does not exist, why not consider shifting to a regime of non-regulation?

Regulate banks and other financial institutions only when they are granted their operation permit, but with the obligation to participate in the rescue of any failing member of banking business. This would internalize the costs from aggressive business strategies of one member. Any bank that walked over the bridge for lender-of-last-resort funds would know it to be the end of its business as an independent operator.

The banking business would thus operate under a mutual guarantee.

The task of the regulators would only be to promote transparency in banking, for example, by requiring banks and other financial intermediaries to publish their balance sheets every month in the main national and local newspapers.

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