Bank Regulation

The first few sections in this chapter consider the approaches to bank regulation. The emphasis in policy proposals is on the approach of prudential and systemic regulation, which is based largely on collective or government action to correct market failures, such as the current credit/dollar crisis. The competing approach focuses on the functions of finance allowing structural changes, including regulation, with the objective of facilitating innovation to promote effective financial systems. Bank functions are then analyzed, providing foundations for the analysis of banking crises. Housing finance is overwhelmingly important in the current crisis. The innovations in securitization and credit-risk transfer have been profound, motivating regulatory proposals. Two important regulations of banks, minimum capital requirements and deposit insurance, are also considered. The final section provides an overview of the political economy of banking regulation. A final section briefly summarizes the chapter.