Institute for Financial Transparency

Shining a light on the opaque corners of finance


What is the Most Efficient Way to Regulate Wall Street?

According to the Federal Reserve’s Vice Chairman in charge of bank supervision,

Efficiency has to be equally important with safety and soundness in our regulatory responsibilities…. We need to achieve safety and soundness, but where we have choices we need to make the most efficient choices…. I don’t think there has to be a trade-off. Safety and soundness in the system is the priority for the regulators but you will always be able to achieve that in more than one way.

Regular readers know the most efficient way to assure safety and soundness in the financial system is for banks to disclose their current exposure details.  This allows the market to assess how much risk the banks are taking and to exert market discipline on those banks who are taking too much risk.

It also allows the market to help the regulators perform their job.

Currently, the regulators must do all of the assessment of the safety and soundness of the banks.  With transparency, the regulators can now turn to the market for help.

Consider for a moment who is likely to do a better job of assessing the safety and soundness of a bank the size of Bank of America:  JP Morgan with its 1,000s of analysts and information systems designed to identify risk or bank regulators with maybe 200 analysts?

If JP Morgan isn’t up to the task of assessing the safety, soundness and the risk a bank the size of Bank of America poses, it suggests Bank of America should be shrunk in size until JP Morgan can assess it.  Of course, the reverse is also true. JP Morgan shouldn’t be any bigger than the analysts at Bank of America can assess.

With transparency, tapping the market for help assessing the risk each bank is taking is only a phone call or email away.

Not only that, but transparency allows the market to discipline banks that take on too much risk and have too little earnings capacity and book capital to absorb the potential losses. Market discipline will include a lower stock price and higher cost to the banks for unsecured debt.

This is a far more efficient way to regulate the banks than hoping bank supervisors can enforce a massive amount of complex regulations.