Fatal Flaw in Private Banking Systems

It is in the interest of banks to expand the supply of credit, and most banking regulations are designed to limit this tendency. It is in the interest of private bank managers to give in to this tendency (in self-interest) and provide credit indiscriminately, irrespective of macroeconomic considerations, as the 2007 crisis has shown. Perhaps we could all learn from India’s risk-averse public sector banks, which are stressed from time to time, but have never seen multiple bank failures.

What caused the financial crisis of 2007? It is important to know because the world is still reeling under the impact of that crisis. If we could determine the answer or answers, we may be able to avert something as devastating in future.

There has been no dearth of explanations: global imbalances, light touch regulation, too-big-to-fail banks, loose monetary policies of central banks, a shift towards securitisation in banking, politicians’ eagerness to expand home ownership in the United States (US), greedy bankers, and so on. Preventing another crisis, many have concluded, amounts to fixing the plumbing wherever it has been shown to be deficient.