Regulators Causing Bank Failures; Returning Banks to Free Market Would Strengthen Economy

The Washington Times (Washington, DC), July 5, 2011 | Go to article overview

Regulators Causing Bank Failures; Returning Banks to Free Market Would Strengthen Economy


Byline: Richard W. Rahn, SPECIAL TO THE WASHINGTON TIMES

Beware Greeks bearing debt - or any other country that has too much of it. Despite ever-increasing government regulation of banks, which often are required to hold government debt as reserves, the systemic risk of a failure in the global financial system is growing rather than diminishing. There are solutions that require less, rather than more, regulation.

Some banks have been around for a couple of centuries or more, particularly in Switzerland, and yet they continue to thrive without government help. Only one Swiss bank out of 350 required state intervention in the financial crisis of the past few years. If you look at the big banks that have been in trouble or the banks that regulators and others worry about being in financial trouble, you will notice that virtually all of them have a corporate form of ownership and are heavily regulated. They also increasingly are being forced to be tax collectors for governments. Yet banks that are organized as general partnerships, such as Swiss private banks, where the owners of the banks have unlimited liability, have, in almost all cases, avoided failure or having to go to the government for a bailout.

To understand why some banks have avoided problems and others seem to have a continuing problem, it is useful to review the basics of banking. Traditionally, a bank takes deposits from individuals and institutions and then lends the money to others, receiving interest from its loans and paying interest on its deposits. If some loans or investments go bad, or if many depositors suddenly want all of their money back, the bank must have reserves to cover such problems. These reserves can be made up of the capital supplied by the owners of the bank, retained earnings and/or government bonds. Bank regulators typically want banks to hold more reserves, while bankers often wish to hold fewer reserves, given that they make little or no money on their reserves.

Bank regulators at the state, national and even global level try to establish minimum reserve requirements for banks to put them on a level playing field and keep them from taking on too much risk. The problem is that every bank has a different risk profile and the regulators have no idea how risky the various assets the banks hold are. One of the fatal conceits held by the political and regulatory classes is that somehow they think they know how risky a bank's asset portfolio is. The politicians and regulators, in part, rely on rating agencies, which have proved to be almost useless in many cases. If a bank's liabilities exceed its reserves, the bank is insolvent, and in the absence of deposit insurance, there likely will be a run on the bank.

Banks that are organized as general partnerships have had fewer problems because the partners have a very strong vested interest not to take on risks they do not fully understand because it is they who take the hit if something goes wrong.

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Regulators Causing Bank Failures; Returning Banks to Free Market Would Strengthen Economy
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