We need a new approach to bank regulation

Waiting until there is a crisis and then deploying ad hoc measures is not good enough

Fifteen years ago, the collapse of the western banking system led to the adoption of thousands of pages of complex regulations. Yet here we are in the middle of another crisis of confidence in banks.

Banks are inherently fragile — they transform short-term and safe funding into long-term and risky lending. This is the alchemy of the banking system. 

The provision of free insurance after the fact is also an incentive to take excessive risks, which leads to ever larger fires.

Governments and central banks must answer two questions. First, which institutions should have access to liquidity from central banks? 

Second, how can we limit the scale of central bank provision of liquidity in a crisis to avoid taxpayer-financed bailouts? 

The basic principle is that banks should always have a contingent credit line from the central bank to cover runnable liabilities. Each bank would decide how much of its assets it would preposition at the central bank. 

In effect, the central bank would be a pawnbroker /Pantbank/ for all seasons (PFAS). 

The PFAS rule is not a pipe dream. Paul Tucker and I encouraged banks to preposition collateral after the financial crisis, and the Bank of England has been in the vanguard of such policies ever since.

This one simple rule could replace most existing prudential capital and liquidity regulation, as well as deposit insurance.

Mervyn King FT 12 May 2023

https://www.ft.com/content/43b926a6-b1ba-47a6-91f7-9ad5f776f8f8

The writer was governor of the Bank of England from 2003 to 2013

Lenders should keep enough collateral with central banks to cover 100% of their short-term deposits in a single day, says Paul Tucker

https://www.ft.com/content/f0fe6555-7929-4b4d-8739-028b3b0aad4e

Central banks would still act as lenders of last resort. 

But they would no longer be forced to lend against virtually any asset, since that very possibility must create moral hazard.

https://englundmacro.blogspot.com/2016/06/the-alchemy-is-belief-that-money-kept.html