One Reason Governments Should Not Regulate Banks

A big reason why governments should not regulate banks is painfully illustrated this week in Banks Battle Weight Issues” in the Wall Street Journal  (July 22). The article focuses on New York Community Bancorp, which is “projected to reach the $50 billion mark by the end of the year if it continues to expand at its current rate.” Here is the key passage:

But with that milestone will come myriad headaches. Once the bank reports assets of more than $50 billion on average for four quarters in a row, NYCB, as it is known, will be large enough to be considered “systemically important” by regulators. That status will require it to comply with stiff rules on capital, submit to yearly “stress tests” and create a road map to wind down the bank in the event of a crisis, moves that will add to its costs. As a result, [the bank’s president] says NYCB is restraining its lending growth, since loans amount to assets. (my emphasis)

Complying with regulations is not free. Picture the bank employees researching the “rules on capital,” analyzing the bank’s balance sheet to check for compliance, and drafting recommendations for needed alterations in the bank’s investment portfolio. Picture other bank employees buying and selling various assets to comply with the rules.

Picture all the bank employees preparing each year for the “stress tests.”

Picture all the bank employees drafting the “road map to wind down the bank in the event of a crisis,” meeting with regulators to find out if the “road map” satisfies them, and updating it as the bank’s condition changes.

Now, what are all these bank employees not doing? They are not making loans. They are not serving customers.

That’s one huge cost of bank regulation. It’s human time and effort taken away from banks’ fundamental role in a healthy economy: investing depositors’ money in productive enterprises.

John Allison, formerly CEO of BB&T Bank (now president of the Cato Institute), says that if he had had a choice between freeing BB&T from all the taxes it had to pay, and freeing it from all the government regulations it had to comply with, he would unhesitatingly have chosen to be freed from the regulations. They are more costly than taxes.

This does not mean that banks should be unregulated! On the contrary, banks should be regulated, but well rather than badly. And for better regulation we need to rely on free market forces. That’s for another post.

Update: A student’s question on how market forces would regulate banks has prompted “another post” sooner than I planned. Here it is.

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One Response to One Reason Governments Should Not Regulate Banks

  1. […] One of my numerous smart and interested students at Towson University (yes, I’m fortunate), a non-economics major named Kristin, has sent me the following question in response to my recent post, “One Reason Governments Should Not Regulate Banks“: […]

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