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Bankwatch is Wrong on the Volcker Rule!

by on February 14, 2012

 The best way to increase transparency and make banks care about the safety of deposits is by exposing depositors to the risks of bad banking by no longer bailing them out.

According to Bankwatch the Volcker Rule will give consumers more choice on where their money should be invested, thus decreasing the risky operations of banks with deposit money. There are many reasons why this will not work, most of these reasons are highlighted in Finical Finance’s post “The Volker Rule:Fixing Problems We Don’t Have.  In my opinion the main reason why this regulation will fail is linked to bad incentives. Incentives do matter! There is little incentive for depositors to choose the safest bank.

Currently all bank deposits are efffectively state backed, as failling banks gets bailed out. Depositors a free to deposit their hard earned savings at the bank offerring the highest return, knowing that they have an implicit garantee. Without a bail-out (this implicit garantee), depositors would loose a proportion of their deposits and will therefore choose their bank more carefully (ballancing both risk and return).

To attract depositors banks, in turn, will need to be a lot more transparent on what they do with their depositors’ cash. It is important for regulators to get incentives right and they should therefore allow depositors to loose money.

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From → Extended Society

3 Comments
  1. I believe we are actually agreeing here. I contend that the Volker rule will differentiate between safe government guaranteed, low interest rate banks that are safe, whereas higher returns are available at investment banks, without government guarantee.

    This would take us back to pre 90’s when bank deposits were only guaranteed up to a certain amount (Canada $60,000 per person).

    By continuing without the Volker rule, you are right, politically it means banks are in effect guaranteeing the risk part of banks, and those bank parts should be allowed to fail, as they did in the pre 90’s.,

    • A rule is the wrong mechanism! There may be far more efficient mechanisms, if you allow market participants to serve each other rather than leap though the loops of regulation. Insurance companies may for instance be willing to offer deposit insurance. Instead of a “rule”, I would prefer to simply give the right incentive. Let customers choose the bank, which they think is safe and allow entrepreneurs to decide how best to attract hard earned savings.

  2. I am certainly not in favour of rules per se. However if we extend your thought process, we must also remove Government guarantees for deposits, both explicit FDIC rules and implicit TBTF rules. Then I would wholeheartedly agree with you. Risky banks would fail to attract deposit money in that scenario.

    This scenario would require more stomach that American law-makers have I believe.

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