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BANK REGULATION

Will Regulators

Catch Up with the Market?

by Randall S. Kroszner

Introduction

The regulation of financial institutions has important

consequences for the efficiency and performance of the fi-

nancial system and the economy as a whole.  Banks play a key

role in encouraging and gathering the savings that finance a

country's economic growth.  By monitoring the use of the

savings they lend to enterprises, banks are an integral part

of the corporate governance system that ultimately affects

the productivity of resources throughout the economy.

Although competition is the traditional means of

achieving efficiency in any sector of the economy, banking

is one of the most heavily regulated industries in the Unit-

ed States.  Most rationales for bank regulation fall into

two broad categories: (1) consumer protection, which con-

cerns potential conflicts of interest when a bank has multi-

ple roles, and (2) safety and soundness, which concerns the

possibility of bank panics and financial instability.  It is

imperative that the regulatory system that has governed

banking with little change since the 1930s be modernized.

Each Congress for the past dozen years has made a major at-

tempt to revise our Depression-era banking regulations,

whose overhaul is long overdue.  Each attempt at fundamental

reform has failed.  Most recently, the House of Representa-

tives of the 105th Congress voted for the first time in fa-

vor of a bill (H.R. 10) that would end those Depression-era

regulations, but the Senate never voted on the measure.  As

the proposed merger between Citibank and the Travelers Group

clearly illustrates, the markets simply cannot wait any

longer for legislative reform and are taking deregulation

into their own hands.

While reform of financial services regulation is ex-

tremely complex, the general direction of reform is clear.

The Glass-Steagall Act of 1933 and the Bank Holding Company

Act of 1956 should be altered fundamentally to permit com-

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Randall S. Kroszner is an associate professor of economics

in the Graduate School of Business at the University of Chi-

cago.