September 15, 2011 12:07PM

Should the Federal Reserve Supervise Banks?

For about all of 5 minutes during the deliberations of the Dodd-Frank Act (to the extent there were deliberations) proposals were offered to separate the conduct of monetary policy from the regulation of banks.  That is, remove the Federal Reserve's supervision of banks and transfer such authority to another agency.  Given the close relationship between Treasury, who was negotiating the bill for the White House, and the Fed, this was never a real possibility.

But would we have been better off removing the Fed's supervision authorities?  A recent NBER working paper by Barry Eichengreen and Nergiz Dincer suggest we would be. The authors examine 140 countries and analyze whether the combination or separation of monetary policy and bank regulation had any influence on the banking sector.

Their results:  1) Relative to countries that combine monetary policy and banking regulation, those countries that separate the two have fewer nonperforming loans as a percent of GDP; 2) They also have lower bank capital requirements, presumably because they have less need to protect against bad loans; 3) savers enjoy higher deposit rates; and 4) there is some weak evidence that separated systems have fewer systemic banking crises.  These all seem like worthwhile goals to me.

Given the renewed, and much deserved, attention the Fed is now getting in political circles, we might actually have the opportunity, under a new President, for reform of our banking and monetary systems that would reduce bailouts and financial crises, rather than increase them.