Reregulation Challenges

Abstract

The financial services industry, centered on banks and various financial markets, has always been a comparatively regulated sector of the economy. The question then is why. How can we justify subjecting finance to a fairly strict system of government oversight and regulation?1 There are several reasons for such extensive government involvement in finance. One is that financial institutions carry a special fiduciary responsibility because they are dealing with other people’s money. A wide range of economic actors must be willing to entrust their savings to financial institutions managing funds on clients’ behalf. These institutions depend on the public’s trust and need to be held accountable to deserve that trust, conditions that are much more likely to be preserved when backed by governmental supervision and regulation. A second reason is the power of financial institutions, in particular banks, to create new money in acts of credit extension. This power gives them a strategic position of great macroeconomic importance. To the extent that this money creation activity, a key source of banks’ profit income, is both subject to procyclical instability and possibly discriminatory inequality, it needs to be regulated by the central bank’s monetary policy tools affecting banks’ reserves used for money creation and also by laws protecting bank clients from outright discrimination.