Economist Special Report on International Banking Regulation

The Economist has a special report this week on regulation of international banking. I thought it was clear, readable, well-ordered, and explanatory on the basic issues under debate (including some brief glossaries of such terms as “resolution authority”). Very good for a class, for example — at the undergraduate or law school level. Titled “Chained, Not Tamed.” But the message is a disturbing one — that actual regulatory reform of the banking system has not really taken place as yet, and, on account of politics, might never. The final section of the report offers an instructive conclusion:

All the same, this report has argued that, on a balance of probabilities, banks that are smaller, more modular and better capitalised are less of a risk to the system than those that are very large and interconnected. These prescriptions are not guaranteed to end banking crises, but they should allow banks to fail more gracefully. There would be costs to making them hold more capital and maintain firewalls between themselves and their neighbours and between their retail arms and investment banks. Yet these costs should not be so prohibitive as to alter the business fundamentally, and will probably be lower than some of the populist regulations now being put in place.

Moreover, these costs should be set against the benefits of lessening the risk of crises that would inflict catastrophic losses. Eliminating that risk altogether is impossible, but if regulators act now while the rules are still malleable, they can make such crises less likely and reduce their harmful effects. Households buy insurance against the possibility that their homes may be struck by lightning. Governments spend vast sums on defence to guard against the remote chance that their countries may be invaded. Yet banking regulators wait for conclusive proof of danger ahead before they act. Until they accept the case for the sort of pre-emptive insurance outlined in this report—tighter regulation, bigger capital cushions, perhaps more separation between different kinds of banking—the clock will continue to tick towards the next financial crisis.