Why Are There So Many Banking Crises? The Politics and Policy of Bank Regulation

Why Are There So Many Banking Crises? The Politics and Policy of Bank Regulation

Why Are There So Many Banking Crises? The Politics and Policy of Bank Regulation

Why Are There So Many Banking Crises? The Politics and Policy of Bank Regulation

Synopsis

Almost every country in the world has sophisticated systems to prevent banking crises. Yet such crises--and the massive financial and social damage they can cause--remain common throughout the world. Does deposit insurance encourage depositors and bankers to take excessive risks? Are banking regulations poorly designed? Or are banking regulators incompetent? Jean-Charles Rochet, one of the world's leading authorities on banking regulation, argues that the answer in each case is "no." In Why Are There So Many Banking Crises?, he makes the case that, although many banking crises are precipitated by financial deregulation and globalization, political interference often causes--and almost always exacerbates--banking crises. If, for example, political authorities are allowed to pressure banking regulators into bailing out banks that should be allowed to fail, then regulation will lack credibility and market discipline won't work. Only by insuring the independence of banking regulators, Rochet says, can market forces work and banking crises be prevented and minimized. In this important collection of essays, Rochet examines the causes of banking crises around the world in recent decades, focusing on the lender of last resort; prudential regulation and the management of risk; and solvency regulations. His proposals for reforms that could limit the frequency and severity of banking crises should interest a wide range of academic economists and those working for central and private banks and financial services authorities.

Excerpt

The recent episode of the Northern Rock bank panic in the United Kingdom, with depositors queuing from 4 a.m. in order to get their money out, reminds us that banking crises are a recurrent phenomenon. An interesting IMF study back in 1997 identified 112 systemic banking crises in 93 countries and 51 borderline crises in 46 countries between 1975 and 1995, including the Savings and Loan crisis in the United States in the late 1980s, which cost more than S150 billion to the American taxpayers. Since then, Argentina, Russia, Indonesia, Turkey, South Korea, and many other countries have also experienced systemic banking crises.

The object of this book is to try and explain why these crises have occurred and whether they could be avoided in the future. It is fair to say that, in almost every country in the world, public authorities already intervene a great deal in the functioning of the banking sector. The two main components of this public intervention are on the one hand the financial safety nets (composed essentially of deposit insurance systems and emergency liquidity assistance provided to commercial banks by the central bank) and on the other hand the prudential regulation systems, consisting mainly of capital adequacy (and liquidity) requirements, and exit rules, establishing what supervisory authorities should do when they close down a commercial bank.

This book suggests several ways for reforming the different components of the regulatory-supervisory system: the lender of last resort (part 2), prudential supervision and the management of systemic risk (part 3), and solvency regulations (part 4) so that future banking crises can be avoided, or at least their frequency and cost can be reduced significantly.

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