Banking for the Public Good

Abstract

Bank shareholders cannot be expected to provide good stewardship to banks because there is a conflict of interests between the shareholder owners and a non-mutually owned bank’s depositors; who provide the bulk of the funds in traditional retail banking and are willing to accept a lower return on their savings than shareholders, in return for lower risk exposure. Regulation is required to protect depositors in the presence of partially funded deposit insurance schemes and taxpayers need to be protected from the resulting moral hazard under which insured banks have an incentive to take on more risk in pursuit of profit. Once some banks become ‘too big (to be allowed) to fail’ (TBTF), they enjoy additional implicit public (taxpayer) insurance that enables them to fund themselves more cheaply than smaller banks. This gives them a competitive advantage. The political influence of big banks in the US and the UK is such that they can be regarded as financial oligarchies, or autarchies that have successfully blocked far reaching structural reform in the wake of the 2007-09 Global Financial Crisis. The TBTF problem and associated moral hazard has been worsened by bank mergers of during the crisis. Alternative solutions to making the banks small enough to be allowed to fail are considered in this paper, but it is difficult to see how they will deliver banks that promote the public good. It is however argued that regulating retail banking as a utility and the pooling of insurance against financial instability should be pursued.