We need a new approach to banking regulation – Mervyn King

We need a new approach to banking regulationFT

Waiting for a crisis and then deploying ad hoc measures is not enough

Mervyn King was Governor of the Bank of England from 2003 to 2013. (See his most important books after this article.)

King presents an impressively simple case for a new regulatory rules structure that goes to the heart of the current 2023 banking crisis. This structure could replace the current rules structure and provide depositor protection within the structure of rules, thus eliminating the ad hoc correction approach in place today for each crisis.

He argues that the current set of regulations miss the mark, that banking crises still occur, and that governments are scrambling to resolve by guaranteeing all deposits, as America has done. And America is worse in its reaction by creating a 2nd and 3rd layer of banker of last resort.

On this blog, I have spoken at length about the need to deal with inadequate funds, of which SVB was a big culprit. King’s phrase “maturity transformation (borrowing short and lending long)” sums this up succinctly.

  • borrow short-term – a simple example is a bank accepting deposits that pay high rates (SVB)
  • long-term loan – taking out loans with a maturity date longer than the deposit short-term borrowing.
  • risk – depositors withdraw their money and without consideration, it quickly turns into a bank run that the Bank cannot pay the depositors. Banks’ assets are linked to long-term loans, hence a bank run.

Moving on to his solution, I can only capture snippets here (because FT is a paid service.)

Mervyn King – FT Opinion

But during the financial crisis, the problem was the reluctance of short-term financing wholesalers to roll over their financing. The lesson is that any so-called “executable liabilities”… can compel the central bank to provide liquidity.

These bodies (banks, insurance companies, pension funds) must either be prohibited from converting maturities (borrow short-term and lend long-term), or have access to central bank liquidity under the conditions below.

  1. prevent banks from issuing more executable liabilities than the central bank is willing to lend against available collateral.
    1. The basic principle is that banks must always have a conditional line of credit from the central bank to cover executable debts.

This simple rule could replace most existing prudential capital and liquidity regulations, as well as deposit insurance. It makes little sense for central banks, as the United States has done, to insure all deposits of a failing bank while maintaining that the upper limit of deposit insurance remains for all the other banks.

Mervyn King on Amazon.com

Tags #bank-regulation #osfi #central-banks #Mervyn-King #maturity-transformation