Policymakers keep solving the wrong banking problem

LONDON – Banks can fail, and often do. Yet whenever this happens, we act surprised. Worse, we look for villains and guilty parties, even when there are none. Risk-loving speculators, greedy investors, regulators asleep at the wheel: someone must be the bad guy. But quenching our thirst for moral adjudication is a poor basis for policy.

The truth is both simpler and more troubling. Banks are peculiar institutions. They take deposits that can be withdrawn at a moment’s notice, and invest in loans and bonds that cannot be redeemed with the same speed, at least not without substantial losses. And what a socially valuable mechanism this “maturity transformation” is: it gives entrepreneurs access to long-term loans that are cheaper than the alternatives, because they are funded with demand deposits that pay no interest.

So, banks are vulnerable by design, not by mistake. No bank is meant to have enough cash in the vault to satisfy the demands of all depositors. Every bank – however conservative its managers and prudent its lending practices may be – can go under if its depositors decide to withdraw their funds simultaneously.