Why Are There So Many Banking Crises? Public intervention in the banking sector.
Thursday, September 3rd, 2009Why Are There So Many Banking Crises? Here are some thoughts:
Although many banking crises have been initiated by financial deregulation and globalization, these crises were amplified largely by political interference.
Public intervention in the banking sector faces a fundamental commitment problem, analogous to the time consistency problem confronted by monetary policy.
The key to successful reform is independence and accountability of banking supervisors.
The main reason behind the frequency and magnitude of recent banking crises is neither deposit insurance, nor bad regulation, nor the incompetence of supervisors. It is essentially the commitment problem of political authorities who are likely to exert pressure for bailing out insolvent banks. The remedy to political pressures on bank supervisors is not to substitute supervision by market discipline, because market discipline can only be effective if absence of government intervention is anticipated. So, the crucial problem is the credibility of political authorities, and the way to restore this credibility is to ensure the independence and accountability of bank supervisors. More work needs to be done in specifying the precise institutional reforms that are necessary to achieve this goal.
These crises have renewed interest of economic research about two questions: the causes of fragility of banks and the possible ways to remedy this fragility, and the justifications and organization of public intervention. This public intervention can take several forms:
emergency liquidity assistance by the central bank acting as a lender of last resort;
organization of deposit insurance funds for protecting the depositors of failed banks;
minimum solvency requirements and other regulations imposed by banking authorities;
and finally supervisory systems, supposed to monitor the activities of banks and to close the banks that do not satisfy these regulations.
