OPTIMAL PRUDENTIAL REGULATION OF THE BANK RISK-TAKING
The 2020 pandemic is likely to result in massive credit defaults. Regulators assure us that banks are sufficiently stable. However, opponents claim that regulation is lax, that it must be tightened and a supranational regulator is vitally needed. To resolve this debate, we return to the basics of the modern banking system. We analyze the evolution of micro- and macroprudential regulation, particularly touching on systemic risk. We find the solution at the intersection of von Hayek’s (1929) theory of full reserve requirement for sight deposits and Ostrom’s (2009) theory of polycentricity, which proves more efficient to optimally use common-pool resources. We elaborate on Selmier’s (2016) watershed-driven recommendations to govern financial markets and extend them to a traffic flow analogy. We conclude with operational recommendations for existing prudential banking regulation revision. We provide additional justification for the need of a full reserve system. This allows to abandon state deposit insurance systems with chronic budget deficits.
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