tem or protect taxpayers from the moral haz-ard created by implicit or explicit govern-ment deposit insurance.
In addition, itscomplexity is likely to make compliance costsfor banks prohibitively high. Indeed, theCredit Suisse Group estimates compliancecosts at an average of $15 million per bank for about 30,000 banks worldwide.
Therefore, other arrangements such as anational treatment for banking regulation, amarket-based regulatory system that relieson a subordinated-debt requirement forbanks, or free banking are worth consideringto determine if those alternatives wouldmake the banking system sounder by provid-ing the right mix of regulation, supervision,and market discipline, so that banks have theproper incentives not to take excessive risksat the expense of taxpayers.
Are Banks Special?
Traditionally, banks and other providersof financial services have been subject togreater government regulation than mostother sectors of the economy. EmoryUniversity economist George J. Benston iden-tifies five main reasons why banks have beenregulated: To provide revenues and otherbenefits to the government; to deal withalleged negative externalities that arise fromthe banks’ activities; to protect consumers; toappeal to popularly elected legislators; and toprotect the regulated institutions from com-petition.
Today, most regulation falls underthe rationale of either consumer protectionor safety and soundness considerations.Why have banks become a prime target of government regulation? Historically, for thesame reason that Willie Sutton robbedbanks: “That’s where the money is.”
Butthere has also been a long tradition amongeconomists that goes back to at least AdamSmith, who maintained that banks are differ-ent from other firms by the very nature of their activities—and because of that, somekind of regulation and supervision is justi-fied. Indeed, in two often-quoted passages of
An Inquiry into the Nature and Causes of theWealth of Nations,
the Scottish economist sup-ported that view, even if regulatory oversightof banks is an infringement on the system of natural liberty that he defended:Over and above the expences whichare common to every branch of trade; such as the expence of house-rent, the wages of servants, clerks,accountants, &c.; the expences pecu-liar to a bank consist chiefly in twoarticles: First, in the expence of keep-ing at all times in its coffers, foranswering occasional demands of the holders of its notes, a large sumof money, of which it loses interest:And, secondly, in the expence of replenishing those coffers as fast asthey are emptied by answering suchoccasional demands.
Smith elaborated,To restrain private people, it may besaid, from receiving in payment thepromissory notes of a banker, for anysum whether great or small, whenthey themselves are willing to receivethem; or, to restrain a banker fromissuing such notes, when all hisneighbours are willing to acceptthem, is a manifest violation of thatnatural liberty which it is the properbusiness of law, not to infringe, butto support. Such regulations may, nodoubt, be considered as in somerespect a violation of natural liberty.But those exertions of the naturalliberty of a few individuals, whichmight endanger the security of thewhole society, are, and ought to be,restrained by the laws of all govern-ments; of the most free, as well as of the most despotical. The obligationof building party walls, in order toprevent the communication of fire, isa violation of natural liberty, exactlyof the same kind with the regula-
To the extent thatbanks as finan-cial intermedi-aries are specialtoday, it is thelegal restrictionsand regulationsunder which theyoperate, not thefunctions theyperform, thatmake them so.