How Regulation makes Banks go Bust
by Celesteh
The recent bail-out of SNS once again shows that competition not regulation is the solution. As Philip Booth explains in “Customers have no incentive to punish mis-selling banks” more regulation (and the implicit consumer protection that comes with it) leads to less critical and knowledgeable customers. With an bail-out lenders and shareholders too have a certain protection. Customers, shareholders and lenders therefore no longer have the same incentive to check financial (mal)practices.
Solution
The solution can only be one with less implicit guarantees derived from regulation. A bail-out by the state must be so unattractive that it should be inconceivable. The terms of the state nationalisation need to include punishments for bad stewardship by the shareholders, lenders, customers and directors that are so severe that nationalisation would be avoided at all costs and other solutions (even bankruptcy) would be appealing. It is time for banks to compete in having the best contingency plan to avoid this unappealing outcome, instead of stating that they are doing what the regulation is telling them to do.
Much like welfare implied guarantees granted from regulation are not a safe safety net for extreme situation, but have become a blanket smothering inventiveness and a competition to the top that society requires.
Denationalisation of Money, Hayek
Good Money, George Selgin
More Sex Is Safer Sex: The Unconventional Wisdom of Economics
Niall Ferguson, The Ascent of Money: A Financial History of the World
The Austrian School, Jesus Huerta de Soto
The Big Short, Micheal Lewis
The Extended Society 
I agree, but I beleive that competetiveness is not enough. I also beleive that the financial sector has to be transparent in order to have a clear view on their ethical behaviour. A well perfoming democracy needs to be able to have some form of control over this behaviour.
Who guards against the politicians? I am all for democratic control. But that means that this process too should be competitive and accountable to its voters.
Great post! I agree that bankers won’t change their practices if they are not really punished for their malpractice. It becomes a win-win situation for bankers and a lose-lose one for the rest of us
http://redbarcelona.wordpress.com/2012/12/19/banks-the-house-always-wins/
Thanks for your comment. I agree that bondholders, shareholder, directors and depositors should feel the pain of bank nationalisation. With too much regulations bail-outs are inevitable.
In your post however I feel you describe banking and the lending function of banking i as an evil practice, which it is not.
The lending function is an evil practice, when the bank knows that there is a high risk that you’ll be unable to return it, charges you more for defaulting and even takes you to court to disposes you even more. This happens when people who are not necessarily used to borrow more are swindled into doing so. Otherwise lending is a fair bet on someone’s capacity to start/expand a business or to purchase something that is above their current liquidity.
@Magentalemon. Remember, without the possibly to lend most of us would be very poor and the poor would remain in a poverty trap. Lending is not evil. Current money is needed to reap returns in the future. Banks play an important role in supplying this short-term credit, in return for the long-term gains.
Where some financial institutions fail is when they lend today’s money, when there is no long -term gain. This leads to two problems. Firstly debtors are unable to pay the bank. Secondly the bank is unable to pay its creditors. To an certain extent the debtors have already had their cake. They will need to pay back what they reasonably can. What my post tries to make clear is that the creditors (bond and shareholder) too should take a cut, as they should have an incentive to only give their money to a financial institution which is going to invest their money properly.