For those of us that maintain a strong interest in the theory of bank regulation (sad, I know) a speech by Ben Bernanke provides a very interesting read. (Thanks to Bank Law Professor for another great link).

In this speech, he runs through what amounts to a history of bank regulation in the USA to illustrate his various points, on what he terms “command and control” bank regulation, deposit insurance and the moral hazard inherent in it, minimum capital requirements and Basel II. A real tour de force.

I was disappointed, though, that he did not mention one major possibility for the regulation of major banking markets.
While he is clearly a fan of what he terms “market-based regulation” he has missed one possibility of doing this truly effectively – establishing competitive regulators.

In this  scenario there would be several bank regulators (as there are currently in the US) but they would operate truly competitively – banks would be able to choose their regulators in a similar way to the way they can currently choose their auditors. The reason I believe this type of system would be able to work is the market forces that would be applied.

A regulator would not owe its position to statute, but to the way in which they are perceived. If they are seen as a light touch, banks using them would be discounted in the market. Banks using a stronger regulator would be advantaged. If a regulator cost too much, however, the bank would be able to move to a cheaper regulator. The discipline applied here, then, would work both ways – the regulator would have an incentive to be the best possible on a risk / reward basis and a bank would have a strong incentive to find a regulator that was well perceived in the market, without it costing too much.

Different regulators could also offer different products, with some offering deposit insurance and others not. Depositors would then have a true choice – higher costs but greater safety or lower cost but no insurance.

Others could specialise in more innovative forms of banking – for example Islamic finance – and offer appropriate products – provision of a Sharia board for example.

There would occasionally be regulatory failure, but I would argue that this sort of failure would be less than the sort of failure we are seeing now in the US, with the FDIC and the Fed stoushing it about the way that Basel II was implemented

All in all, a great speech for a read, but I would have liked to see this other opt

ion mentioned.