Wednesday, March 4, 2009

The folly of capital requirements

Jeffrey Hummel at the History News Network has a great post (which repeats information originally give by Less Antman) on the harm of capital and reserve requirements, and how deposit insurance encourages banking consumers to ignore the risks their banks are taking with their money:

"While foresighted bank executives might have chosen to maintain capital in excess of regulatory requirements so that a decline in value wouldn't trigger a crisis, it would have made no business sense to do so, since it would have reduced their lending income and ability to pay competitive rates on deposits or offer other benefits to attract customers. In a free market, they would have been able to do so, since they would have gained a reputation advantage from their greater safety, but with FDIC insurance protecting all deposits, customers don't shop based on safety, as they assume they are protected by the government from the loss of their deposits. Thus, only the rates and benefits offered by a bank matter to a customer, not the reliability of the bank, thanks to the FDIC."

The whole post is well worth reading, as it delves into some of the other unintended consequences of bank regulation.

2 comments:

Less Antman said...

You'll have to forgive my desire for ego gratification, but as Jeff Hummel notes in his post, he is quoting ME. In any event, I'm delighted you found my comments on mark-to-market accounting interesting.

Raționalitate said...

Sorry about that - proper attribution now given!