The Future of Banking Regulation*

The banking crisis of 2007/08 saw a combination of new conditions give rise to reminders of old truths about the rationale for banking regulation. The crisis reminded politicians that banks are special. The collapse of no other sort of financial institution has the capacity to create queues of people standing in a line waiting to get their money. The collapse of no other sort of financial institution has such an immediate and dramatic effect on the real economy. The crisis reminded commentators that, in reality as opposed to in economic theory, the bigger banks at least, enjoy the benefit of a guarantee from governments so that, even if their shareholders lose out, their depositors will be fully compensated so that systemic risk does not occur.1 The German government may have been forced by the European Commission to waive its legal guarantee of the publicly owned Landesbanks in Germany, but the economic reality is that deposits with large banks, whether privately or publicly owned, enjoy the benefit of an implicit government guarantee. Finally, the crisis reminded everyone that, in the end, banks are regulated because of worries about risk. And the reminder of that fact presents us with a problem: the problem that we discovered no-one knew or could calculate the risk profile associated with securitized products. The banks did not know, the buyers did not know, everyone was relying on the credit reference agencies and their computer programs (or at least Moody’s) were wrong.