The Idea That the 2007-2008 Financial Crash Demonstrates That Banks Need Regulating More Tightly Is Certainly Contestable

Following the financial crash of 2008, central banks and financial regulators have accrued many new powers. The consensus following the crash was that commercial banks, unless more tightly controlled, were a potential danger to financial stability and the wider economy. Banks in most developed countries have had structural changes imposed upon them and have had their capital more tightly regulated. There has also been a huge increase in the regulation of the conduct of banks. In addition, central banks have adopted so-called 'macro-prudential' policy instruments which attempt to reduce the supply of credit to particular areas of the economy.

The idea that the crash demonstrates that banks need regulating more tightly is certainly contestable. For example, it is clear that there was very little that central banks and financial regulators did in the 2000s that made the crash less likely or its effects more benign. Indeed, much that they did made things worse. Monetary policymakers in the US held interest rates down and stoked the boom. Many of the approaches to regulation encouraged the development of the kind of financial instruments that many believe were at the heart of the crisis. In addition, especially in the US, the government underwriting of financial risk in a number of areas of the financial system encouraged risk taking and lending to risky counterparties. Central bankers and regulators also did not have unique foresight into the events that would unfold. This should call into question approaches to promoting financial stability that involve more regulatory and central bank control of the financial system. For example, the first sentence of the last Bank of England Financial Stability Report issued before the financial crisis started in the UK read: 'The UK financial system remains highly resilient.' Paul Tucker, head of market operations at the Bank of England said in April 2007: 'So it would seem that there is a good deal to welcome in the greater dispersion of risk made possible by modern instruments, markets and institutions.' They were the very instruments that were at the seat of the crisis (though they did not, as such, cause the crisis) and which were encouraged by regulatory and other interventions, especially in the US.

--Philip Booth, foreword to Financial Stability without Central Banks, by George Selgin (London: Institute of Economic Affairs, 2017), ix-x.