You shouldn't be trying to create a system where no bank fails but you should be creating one that catches a bank and allows it to fail without impacting the financial markets.This is exactly the result that would be achieved with adherence to the FDR Framework and especially insuring that market participants have access to all the useful, relevant information in an appropriate, timely manner.
With the data made available under the FDR Framework, each bank could analyze its competitors. Using the results of this analysis, each bank could determine how much exposure to another bank they were willing to have. In addition, each bank could properly price this exposure based on the other bank's risk.
Since each bank has the ability to analyze the solvency of every other bank and adjust its exposure well ahead of solvency becoming a critical issue at an individual bank, the problem of contagion is minimized. As a result, banks can once again fail.
Mr. Diamond was also concerned with
Finding the balance between making financial institutions safe and secure and also fostering economic growth and job creation is what we need. We need tough supervision and monitoring of these rules so that we don't run into the situation again where banks fail. Capital is at the right levels but people shouldn't believe that no banks ever fail.The strength of the FDR Framework is that it does a superior job of balancing making financial institutions safe and secure while also fostering economic growth than do capital requirements by themselves.
It does this by expanding of the supervision and monitoring of banks beyond the regulators to the peer banks. This brings market discipline to the banking industry.
At the same time, it supports the creation of properly priced credit. If credit is underpriced, the risk of the bank increases and so does its cost of funds.
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