More than five years after the financial crisis and the need for a robust means of financial regulation has never been stronger. Banks have become inherently unstable institutions built upon risky systems of high leverage, and the increased emergence of non-financial lenders or “shadow banks” across Europe and the US has made regulation in the sector a near impossible task.
David Thesmar is a professor of finance at HEC Paris business school, and former Eurozone forecast manager for the Ministry of Finance. He argues that methods such as forcing banks to deleverage will encourage asset transfer from banks’ balance sheets to the inherently risky shadow banking system. Likewise, with governments reducing their debts, shadow banks will only grow stronger.
“The key modern challenge for an effective means of regulation for the financial system is therefore implementing a means of monitoring to enable us to evaluate the network as a whole,” he says. “Central banks are already embarking this task, but it is only the beginning.”
Instead, he believes the best way or restabilising is through ‘limited purpose banking’.
“Ultimately, one way out of all this is “limited purpose banking”, a world where banks do not perform maturity and liquidity transformation, but where deposits are shares of mutual funds that can be exchanged for cash on a secondary market. This would be a true revolution in banking.”