Central banks have gone too far in regulating the bank sector. The complexity of regulation creates uncertainty in the system and excessive costs. Unnecessary regulation doesn’t reduce the risk for future financial crises, says Anjan Thakor, professor of finance at Washington University in St.Louis and part of CFF:s advisory board, at the CFF conference on Bank Stability and Regulation held in Gothenburg on June 1-2.
First of all, what do you think of the conference?
I think the conference has been a tremendous success with very good papers presented and we have had very good discussions. This conference was by invitation only, which makes it small and that is nice. If we will do something similar again I would like to see some policy people involved. Getting regulators in the same room, and to mix academics, policy makers and practitioners we could further the discussions.
What are the messages of the conference?
I think that there are a number of messages that have come out of this conference. One of the most important issues is how governments cope with systemic risks in banking. To a certain extent systemic risk is an outcome of a central bank's behaviour. A systemic risk is when the whole banking sector is at risk as we saw in 2007-09. It wasn’t just the financial system in one country but the whole global financial system that was threatened to collapse. One of the goals of central banks is to deal with systemic risk but one of the drivers of systemic risks is actually the central banks themselves.
Can you explain this a bit further?
This is because central banks make prudential regulation decisions that determine banks' capital levels, which can affect systemic risk. Set capital requirements too low and, the research shows, that you get failure contagion among banks. Central banks also determine monetary policy. Have an excessively easy money policy and you get price bubbles like we saw in housing prior to the 2007-09 crisis.
What was your talk about?
The paper I presented basically says: look, if governments and central banks insist on bailing out failing banks, then that actually raises the probability that you will have failing banks. Experience show that in economies where governments have intervened more, these countries have had harder times recovering from the crisis and industries have become weaker. We are intervening in the market to an unprecedented extent through the central banks, and at the end of the day somebody has to pay for it – the taxpayers.
You have mentioned that after a crisis there is a tendency to introduce too strong regulations as a fear of repeating the problems. What do you say about the present situation?
I think a lot of things have improved, but there are two things with the present situation that concern me: one is that we have excessive and complex regulation. When we increase the complexity of the regulation it means that the behaviour of the regulatory institutions and the response to regulation has become more difficult to predict, which creates uncertainty in the system. In that sense we pay too much attention to the crisis and we are inhibiting economic growth because of the cost of excessively complex regulation.
Secondly, I think we have sort of collective amnesia as we are already forgetting what got us into trouble in the crisis. Due to low economic growth in the Euro-zone and rather low GDP growth in the US, we now hear governments and central banks talking about pushing banks to lend more. But that is like a call to go back to the lending booms that got us into trouble in the first place.
Is it possible use regulations to prevent another financial crisis or are crises inevitable?
That is what I have written about and presented to the US Chamber of Commerce. I think we should do two things. First, we should try to lessen the burden of regulation on banks when it comes to things that don’t have to do with safety and soundness. In exchange I would like to increase the capital requirements in banks especially when they are doing well. In good times we should raise capital requirements and during bad times we should lower them. We need to do that very deliberately because the more regulations we impose on banks the more activities tend to go outside banking into the so called shadow banking system. So if you impose capital requirements you should also impose them on shadow banks, such as hedge funds and investment banks. We need regulate by functions rather than labels.
Link to Anjan’s conference paper: International Financial Markets: A Diverse System Is the Key to Commerce
Link to Anjan’s website