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Banking Regulation Exists, It’s just Bad

July 1, 2013

There was a recent Daily Show clip highlighting the disparity between U.S. and Canadian banking regulation (unfortunately the link has died, R.I.P.). Canada’s bank regulation is among the most effective in the world and Canada simply doesn’t have the number or severity of banking crises that the U.S. does. However the hedge fund manager on the clip refers to America’s banking sector as a bastion of the free market, but nothing could be further from the truth. Denying there is financial regulation in the U.S. is just as insane as denying that America has a military or denying the existence of Medicare. In addition to the dozens of laws passed concerning financial regulation, the U.S. has 10+ agencies tasked with regulating the financial sector:

The Treasury Department
U.S. Securities and Exchange Commission (SEC)
Financial Industry Regulatory Authority (FINRA)
Commodity Futures Trading Commission (CFTC)
Federal Reserve System (“Fed”)
Federal Deposit Insurance Corporation (FDIC)
Office of the Comptroller of the Currency (OCC)
National Credit Union Administration (NCUA)
Office of Thrift Supervision (OTS)
Consumer Financial Protection Bureau (CFPB)
Federal Housing Finance Agency
Fannie Mae/Freddie Mac (quasi-governmental)

Whatever the troubles of the U.S. banking sector, underregulation is not among them. However, many people have a misconception of what the nature of regulation is. Regulation is a set of rules which firms have to follow. They can be either good or bad, and outcomes depend not on the quantity of them, but on what they consist of. No one in their right mind would blame the loss of their favorite sports team on “the rulebook not being big enough”. Similarly, bad outcomes in the economic sector depend not on the size or complexity of the regulation, but on its particular composition.

In America, when Congress deigns to write a financial law, the first people they call up are the major investment banks. The regulations are bought and paid for by the banks. If you think more regulations are the answer, you’ve got to ask yourself, why would a bank write a regulation that hurt it? Most people just see “Financial Reform” in the title of a newspaper article and assume all is right with the world, at least they do until the next banking panic hits.

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5 Comments leave one →
  1. Tessa Madden permalink
    July 9, 2013 5:50 pm

    Requirements are imposed on banks in order to promote the objectives of the regulator. Often, these requirements are closely tied to the level of risk exposure for a certain sector of the bank. The most important minimum requirement in banking regulation is maintaining minimum capital ratios .

    • February 20, 2014 5:20 pm

      IMO, capital ratio regulation is quixotic at best. Regulators have neither the knowledge not the incentive to effectively manage bank’s capital ratios. Furthermore, when a crisis hits, no capital buffer, no matter how large is sufficient to insulate a bank from a downturn if the buffer is comprised of risky assets. We saw this in the 2008 crisis. Banks had a lot of capital, sure, but it was all mortgage backed securities rated at AAA, but in reality were high risk. It’s better to run them all through speed bankruptcy, book the losses and move on.

  2. February 18, 2014 8:15 am

    Shame the linked video is no longer available.

    • February 18, 2014 10:41 am

      Thanks for letting me know. I’ll add a note and remove the link. Basically they make fun of the Canadians for having a functional banking relator and interview US financial people saying why can’t we have functional regulation.

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