Regulation:problem or solution?

Forrest CapieMadrid 2015

Trust and regulation• What response to a crisis?

• Regulate – recent crisis/crises

• Deregulate – 19th century crises

• Depends on trust

• David Hume: trust better than legal exaction

Herbert Spencer• “Among unmitigated rogues, mutual trust is

impossible. Among people of absolute integrity, mutual trust would be unlimited … Given a nation made up entirely of liars and thieves … nothing in the shape of promises to pay can pass in place of actual payments; … On the other hand, given a nation of perfectly honest men – nearly all trade between its members may be carried on by memoranda of debts and claims, eventually written off against each other in the books of bankers..”

Money is key• Increases economic efficiency

• Barter ->• Commodity money ->• Metallic money ->• Paper money ->• Bank money ->

• At each step there is a lowering of transaction costs

Money requires trust• Unit of account; store of value; means of payment

• These allow a payments system

• Hindered by lack of trust in value of money

• Need a guarantee on future value

Arguments for regulation

• Competition where possible

• Regulation where necessary

• Market failure

• Too readily found

Against regulation

• G Stigler: exercise of coercive power

• Regulatory failure

• Government failure

• J Kay: detailed regulatory rules ineffective

Banks are different• Interdependent

• Transmit monetary policy

• Transmit from lenders to borrowers

• But case for protection is flawed

Regulation phases• Mercantilism – up to 18th/19th century

• Laissez faire -1820s/1830s onwards

• Return of regulation – post WWII

• Myth of deregulation

Some history• 1825 Crisis• Monetary ease abundant credit• Bank of England central• Commercial banks issuing freely• Great boom• Fear• Monetary tightening• Crash

Response to 1825• Slow, hesitant, ignorant

• Hampered by regulation

• Eventually as Joplin and Stuckey suggest

• Gradually learn over next 40 years

How was deregulation achieved?

• Revulsion against the ‘old corruption’

• ‘the widespread use of pensions, sinecures and gratuitous emoluments granted to people the British government wished to bribe, reward or buy’

• BoE: ‘more base in its origin, more revolting in its association, and more inimical to general freedom’

• BoE: ‘as a bastion of government and monopoly, and as a parasitic element itself upheld by a network of patronage and corruption’

Deregulation• Usury laws

• Joint stock banking allowed, but restricted

• Joint stock restrictions eased

• Gold standard more clearly defined

• Limited liability allowed – choice in governance

Bank capital I• Banks need capital for protection

• Basel regulation pro-cyclical

• Regulatory capital is not usable – minimum

• Recent crisis – banks to raise capital ratios

Bank capital II• What should happen?

• Leave banks alone – 19th century trust

• Very lightly regulated – no regulation on capital

• Ratios rose and fell

• 100 years of stability

Bank capital III• “there is no rule of thumb method of deciding the

size of the capital funds which a bank needs to carry on its business. The guiding principles are that the resources as a whole must be sufficient to provide absolute security for our depositors and the reserves sufficient to meet fluctuation in our trading from year to year …”

• Chairman of Lloyds’ Bank in the 1950s

Return of regulation• 1970s

• Banking Act 1979

• Banking Act 1987

• Basel I

• Basel II

Trust again• Parliamentary Banking Commission – restoration

of trust

• But how?

• Different policieso Increased regulationo Redistributive from savers to lenders

Resolution regimes• Tacitus: “corruptissima republica plurimae leges”

• Need less regulation and better thought out

• Banks need to fail

• Lenders know best

Incentives

• “A substantial banqueier is to be hanged hear today for making bankerupt; I know not whether that bee ye best way of preventing others from ye like practices.” Henry Savile, an british envoy in Paris writing home in 1692

Conclusion• Opportunity missed• Regulation the problem• Need simplified framework• Need credible resolution regimes• Bankruptcy laws revised• Possibly some unlimited liability