It’s the banking regulations, stupid

LONDON – Do more bank “bailouts” amount to more proof that capitalism doesn’t work? Some commentators seem to think so. But what capitalism are they talking about? It has been a long time since there was any trace of market discipline or capitalism in banking, one of the most heavily regulated industries of all. Coming on the heels of the travails of Banco Popular and other banks, the failure of Silicon Valley Bank (SVB) is another case of an institution collapsing overnight without breaching any of the many prudential regulations by which it was governed.

The 2008 global financial crisis exposed the horrendous mistakes that banking regulators had made in the preceding years. But rather than correcting them and developing a robust understanding of why these errors were committed and how they could be avoided in the future, politicians and the public at the time demanded that supervisory authorities simply double down on regulation. So, that is what they did, and we are now seeing the results.

The main mistake in contemporary banking regulation is the requirement of only a razor-thin capital cushion. This is an artefact of a previous era. It is based on the capital that Japanese zombie banks had in the mid-1990s, reflecting the desire among those writing the Basel rules (the international banking regulation framework) not to embarrass their colleagues at the Bank of Japan.