There some truth to this

Peter Sands, the chief executive of Standard Chartered, warned that much of the new regulation could \”stifle growth\” and was contradicting governments\’ fiscal and monetary policies that are attempting to support countries coming out of the recession.

“What I most worry about is that in the next cycle, as the regulatory pendulum swings, we are going to have to use taxpayer money to bail out unregulated businesses that, unlike the banks in the last crisis, may not be able to repay them,” he explained.

He said that new regulation was important but there was a major risk of over-engineering the solution.

Gary Cohn, president of Goldman Sachs, warned regulators must focus on the whole financial system, rather than just banks.

Mr Sands comments, made on Wednesday at the World Economic Forum in Davos, are echoed by many banking leaders spoken to by The Telegraph. They said they were losing patience with endless “bank bashing” by politicians and regulators.

A reasonable description of what went wrong is that the shadow banking system suffered a run. What triggered it isn\’t all that important: yes, mortgage bonds, a housing bubble, gross overpayment for ABN Amro, these had a part to play.

But the real problem was what this led to: the wholesale markets, that shadow banking system, freezing up and damn near toppling the whole edifice of the financial system. Those stories of ATMs not having cash in two hours time: nothing to do with mortgage losses. They were due to the interbank system, overnight etc, disappearing.

OK, so what was the problem with this shadow banking system? Banking systems, at least fractional reserve ones, which do not have deposit insurance are likely to be subject to runs. Hmm.

But why did this shadow banking system grow up? Because the players in the market were looking for ways to get out from under what they saw as the stifling regulation of the insured and thus regulated parts of the banking system.

They may have been clever or dumb about this, perhaps they should or shouldn\’t have done this, but that is one way of describing what had been going on for decades. Not just regulation of course: tax as well. The entire Eurobond market started as tax arbitrage out from under the US system of bond taxation.

OK, so we\’ve narrowed down our root problem as being part of the banking system growing outside of the regulatory structure. Growing there as a way to escape from what was considered to be onerous regulation.

Which leads to the policy implication: we really don\’t want to make the new regulations so onerous that what we encourage is the growth of a second unregulated shadow banking system. One which will, in hte fullness of time, most likely fall over again.

It\’s a tricky balance but there isn\’t, in anything close to a free society, any method of doing anything else. Ban this and ban that and people will simply construct a stucture even further out there: and yes, as and when this falls over it will be necessary to bail it out again. Simply to stop the whole system crashing.

Too much regulation will lead to exactly the problem that everyone wants to avoid: as will too little of course.

3 comments on “There some truth to this

  1. No such thing as a ‘shadow banking system’, it’s a myth invented by G Brown. What there are are large funds, pension funds, sov wealth funds, really rich foreigners etc who lend money to or invest money in regulated banks.

    Seeing as the BoE, FSA and so on know perfectly well where the banks get their financing from, there’s nothing ‘shadowy’ about it. Or is it a rule that a man with £1,000 on deposit is a depositor and a man with £1 billion on deposit is a shadow banker?

    These so called ‘shadow bankers’ do not take deposits or deal with general public, ergo they are not banks, ergo they cannot be ‘shadow banks’.

    The bitter irony in all this is that the ‘shadow bankers’ (whom everybody likes to slag off) are largely synonymous with ‘bond holders’ who are exactly the people who benefitted most from the bank bail outs (a debt-for-equity swap would have sorted this out admirably).

  2. Did the interbank lending market freeze when lenders realised CDOs weren’t what they had been purported to be?

    Wholesale money markets might not be regulated but the businesses that use them are.

  3. The concept of deposit insurance has failed. Its existence removed the need for depositors to care about the health of their bank until it was too late (e.g. NR). Then, when the banks failed, the previously agreed deposit insurance limits were not implemented, as governments decided to retrospectively guarantee the banks beyond these limits.

    Worries about the ATMs emptying: The problem with the day-to-day access of deposits for paying bills etc is that we do not segregate:

    A. Deposits in a non-fractional reserve, government-guaranteed system

    from

    B. Interest earning savings (ideally all in fixed term bonds) in a fractional reserve system with no government guarantee whatsoever.

    Regulate so that A is secure, for each bank and the system as a whole, no matter what happens to B. Then let market forces apply to B with the minimum of government regulation.

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