Academic journal article Journal of Money, Credit & Banking

Competitive Banking, Bankers' Clubs and Bank Regulation

Academic journal article Journal of Money, Credit & Banking

Competitive Banking, Bankers' Clubs and Bank Regulation

Article excerpt

There has been considerable interest recently in what might be called the microfoundations of banking regulation and central banking. Much of this interest is stimulated by the revival of the free banking school which sees government-supported (official) regulation as unnecessary and central banking as the damaging product of state intervention. Yet free banking is still a minority view, and most economists continue to believe that official" regulation has a useful role to play. This latter view has been defended and developed in recent years by Gorton and Mullineaux (1987), Mullineaux (1987) and Goodhart (1987, 1988, 1991). In very different ways - Gorton and Mullineaux use a contractual approach and Goodhart the theory of clubs - these writers have argued that information asymmetries in financial markets posed problems that unregulated markets could not handle, and they argue that regulation arose "spontaneously" to meet these problems. According to this view, banking regulation and central banks should be seen, in part at least, as a "natural" response to problems inherent in financial markets, and the free bankers' view of diem as no more than damaging intrusions should be rejected.

This paper sets out a contrary view. Information problems do play a large role in financial markets, and these problems might lead free banks to form "clubs" or comparable hierarchical structures that restrict (that is, regulate) the activities of member-banks. But this regulation does not justify the systems of financial regulation or central banking that arose historically because it differs from them in critical ways. Furthermore, since the benefits that regulation can bring are basically economies of scale, arguments for spontaneous regulation would appear to be tantamount to claims that banking is a natural monopoly and the empirical evidence indicates it is not. In any case, arguments for spontaneous regulation are also refuted by the evidence that the historical banking systems that were relatively close to laissez-faire developed little or none of it, and there is a plausible argument that the nineteenth-century U.S. cases often cited as examples of "private" regulation only developed such regulation as a response to branching and other restrictions that prevented a more explicit appropriation of economies of scale.

The focus of the paper is thus to dispute claims that regulation and central banking were a natural, spontaneous response to inherent market failures, and in doing so to suggest that they are not economically justified as improvements over a free market. The paper has less to say on the more difficult questions of why governments and central banks behaved as they did, and what other justifications they might (or might not) have had. While free bankers such as White (1984, 1989), Selgin (1988), Dowd (1989), and Glasner (1989) have claimed that interventions were often motivated by essentially political factors - to distribute favors, or to raise revenue - free bankers have never to my knowledge argued that they always were. What they have claimed is that even when governments intervened to sort out genuine banking problems, governments were actually trying to resolve problems stemming from their own earlier interventions, and not problems that could properly be ascribed to a free market.(1) Nor have free bankers denied that central banking to a considerable extent evolved, but they would insist that the evolutionary process itself was heavily influenced by the state. In short, the paper does not deny that governments might sometimes have felt they had legitimate reasons to intervene,(2) but it does dispute the claim that interventions were justified by failures inherent to a free market.

THE RATIONALE FOR BANKING CLUBS

Suppose that there is more than one bank in a relatively unregulated equilibrium. It is well understood by now that mutual interest will lead them to cooperate with each other to clear their notes and checks through a clearinghouse (see White 1984; Selgin and White 1987), but banks will also want to deal with each other for purposes other than clearing (for example, to lend to each other) and we wish to investigate whether they would cooperate on an explicit "market" basis (that is, where each deal was done separately), or whether they would do so by forming a club to coordinate at least some interbank activity by command. …

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