In a speech by Jon Nicolaisen, Deputy Governor of the Central Bank of Norway, he asks should banks be bailed out.
No. One of the benefits of the Transparency Label Initiative™ is it renders bank bailouts unnecessary.
Under the Initiative, there are two types of banks: those that provide transparency and are awarded a label and those that are opaque and do not have a label. For banks with a label, investors in their unsecured debt and equity securities know they will suffer losses if the bank runs into difficulty. As a result, they will exert market discipline to restrain risk taking to prevent losses from the bank wiping out their investment. For banks without a label, regulators can increase their capital requirements to prevent any possibility of a need for a bailout.
However, the Initiative has not yet formally announced which, if any, banks have been awarded a label. So bank regulators still perceive themselves to be faced with a choice of bailout or don’t bailout.
As I discuss in Transparency Games, the primary driver of the choice to bailout the banks is fear. Regulators fear there would be unimaginable consequences if a Too Big to Fail bank failed. In his speech, Mr. Nicolaisen’s confirms this.
We bail out banks to prevent systemic crises. We bail out banks to limit the substantial damage a deep banking crisis can inflict on the economy.