What’s Wrong with Prudential Bank Regulation and How to Fix It

What should be our destination? We want a regulatory system that credibly requires banks to risk their stockholders’ investments, not taxpayers’ wealth. And we want to avoid permitting losses to bank stockholders to cripple banks’ abilities to make loans to viable borrowers in the wake of severe bank losses. These goals point to common regulatory objectives: requiring banks to maintain adequate amounts of equity capital and cash assets relative to the risks they undertake, and ensuring that the risks banks’ bear are properly diversified across sectors so that a normal recessionary shock coming from one sector (e.g., real estate) does not lead to an economy-wide contraction of credit. Of course, avoiding bailouts and credit crunches isn’t everything: we need to build a competitive banking system that is able to adapt to changing market conditions to provide a broad range of services to its customers at low cost. U.S. banks are still struggling to recover their competitive capabilities, partly owing to the new regulatory burdens that they are bearing in the wake of the Dodd-Frank Act of 2010.

Charles W. Calomiris

U.S. House Committee on Financial Services

July 23, 2015

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