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Should we deregulate the banks?

The deregulation of the UK banking system in the 1980s was a monumental event in the history of banking. A desperate attempt to make financial services in the UK more competitive with foreign banking.

In order to raise the level of competitiveness a banking system, regulations are typically reduced. The objective of this deregulation is to generate higher productivity and more efficiency. This a clear benefit of deregulation and is no more evident than in the UK in the 1980s where deregulation prompted a boom in the finance industry. On the flip side, however, it did also result in many smaller banks being taken over by bigger players which resulted in the formation of the big four UK banks that have dominated the market ever since.

This creates a concentration risk where the fall of one or more of these bigger players threatens to bring down the rest. The balance, therefore, between, deregulation and concentration risk is key to achieving higher productivity and efficiency whilst thwarting the risk of a financial crisis.

It is clear that bank regulation can provide protection benefits which prevent financial institutions from abusing customers and taxpayers. Regulation ensures banks do not engage in risky deals, with agencies determining what can be considered appropriate risk and implementing limits which a bank cannot go beyond. Systemic risks are also reduced where government intervention in protecting liability holders, particularly in large financial institutions, reduces the probability of financial difficulties spreading to other financial institutions.

This risk monitoring amongst large financial institutions, therefore, helps prevent the failing of interconnected institutions who have significant exposure to the larger financial institutions. At an investor level, small savers seek information from regulators as to their safety evaluation of a large financial institution. The information they otherwise would not have been able to access to aid their investment decisions. This information provides consumers with peace of mind and the ability to make sound choices with their deposits.

Deregulation, however, is said to breed competition, with unsuccessful banks being eliminated from the market leaving only the prosperous one behind, thus generating a more efficient and productive market. The gradual removal of restrictions opens up opportunities for banks to be more proficient in their apportionment of resources and to expand their operations to reduce their costs.

The removal of restrictions allows banks to increase their operations on a global scale and to lend anywhere they choose, thus increasing their market share and driving increased economic growth. The higher level of freedom resulting from deregulation provides banks with a greater impetus to compete, to grow, and to expand as the threat of greater competition forces continuous improvements in efficiency and consumer service. These freedoms, however, must be considered carefully alongside the less welcomed outcomes that also arise following reduced regulation. Outcomes that are evident no clearer than in the financial crisis.

Ultimately, the increased competition typically born from deregulation comes with a sacrifice of a loss of our smaller institutions. Institutions that are typically swallowed by the superior players in the market who are best equipped to lower costs and expand their operations globally.

Additionally, deregulation limits the powers of agencies which can allow competition to escalate to undesirable levels. With reduced monitoring and regulation, institutions can engage in risker, and sometimes illegal, operations with the sole aim of maximising their profits. This, as we have seen in the past, can have devastating effects. Ones we would not wish to arise again in the future.

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© 2020 by James Thomas Consulting.