Regulation: Problem or Solution? Forrest Capie, Madrid 2015 1) Trust and regulation are interdependent, with more regulation enacted during times of crisis but deregulation occurring during periods of greater trust. 2) Money and banking require trust to function, but excessive regulation can hinder competition and innovation while failing to address market failures or prevent regulatory failure. 3) The history of banking shows that periods of deregulation in the 19th century corresponded with over a century of banking stability in the UK, while increased post-WWII regulation has been pro-cyclical and flawed. Simplified frameworks with resolution regimes may better promote trust than complex regulations.

1. Regulation:Regulation:
problem orproblem or
solution?solution?
Forrest Capie
Madrid 2015

2. Trust and regulationTrust 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

3. Herbert SpencerHerbert 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..”

4. Money is keyMoney is key
• Increases economic efficiency
• Barter ->
• Commodity money ->
• Metallic money ->
• Paper money ->
• Bank money ->
• At each step there is a lowering of transaction costs

5. Money requires trustMoney 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

6. Arguments for regulationArguments for regulation
• Competition where possible
• Regulation where necessary
• Market failure
• Too readily found

7. Against regulationAgainst regulation
• G Stigler: exercise of coercive power
• Regulatory failure
• Government failure
• J Kay: detailed regulatory rules ineffective

8. Banks are differentBanks are different
• Interdependent
• Transmit monetary policy
• Transmit from lenders to borrowers
• But case for protection is flawed

9. Regulation phasesRegulation phases
• Mercantilism – up to 18th/19th
century
• Laissez faire -1820s/1830s onwards
• Return of regulation – post WWII
• Myth of deregulation

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

11. Response to 1825Response to 1825
• Slow, hesitant, ignorant
• Hampered by regulation
• Eventually as Joplin and Stuckey suggest
• Gradually learn over next 40 years

12. How was deregulationHow was deregulation
achieved?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’

13. DeregulationDeregulation
• Usury laws
• Joint stock banking allowed, but restricted
• Joint stock restrictions eased
• Gold standard more clearly defined
• Limited liability allowed – choice in governance

14. Bank capital IBank capital I
• Banks need capital for protection
• Basel regulation pro-cyclical
• Regulatory capital is not usable – minimum
• Recent crisis – banks to raise capital ratios

15. Bank capital IIBank 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

16. Bank capital IIIBank 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

17. Return of regulationReturn of regulation
• 1970s
• Banking Act 1979
• Banking Act 1987
• Basel I
• Basel II

18. Trust againTrust again
• Parliamentary Banking Commission – restoration of
trust
• But how?
• Different policies
o Increased regulation
o Redistributive from savers to lenders

19. Resolution regimesResolution regimes
• Tacitus: “corruptissima republica plurimae leges”
• Need less regulation and better thought out
• Banks need to fail
• Lenders know best

20. IncentivesIncentives
• “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

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