Banking can be made honest and fail-safe

In case no one has noticed, everyone who has testified before the Parliament's Commission on Banking Standards has concluded that the combination of complex rules/regulations and regulatory oversight will neither make banks honest nor fail-safe.

This list of high-powered witnesses includes the UK Chancellor, George Osborne, the Governor of the Bank of England, Sir Mervyn King, a leading contender as next Governor of the BoE, Paul Tucker and former Fed Chairman Paul Volcker.

As an example of why the combination of complex rules/regulations and regulatory oversight will neither make banks honest nor fail-safe, each of them looked at the flaws in the proposals to separate investment and retail banking using the Volcker Rule, ring-fencing or complete separation.

Your humble blogger was thrilled that all of these distinguished individuals confirmed what I have been saying all along about the combination of complex rules/regulations and regulatory oversight is not an effective substitute for transparency and market discipline.

Everyone knows that requiring the banks to provide ultra transparency and disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details would make the banks honest.

Sunshine is the best disinfectant.

Everyone also knows that transparency makes the banks fail-safe.

With access to the information disclosed through ultra transparency, market participants can independently assess the risk of each bank.  With this risk assessment, market participants can adjust the amount of their exposure to each bank to what they can afford to lose given the risk of each bank.

As a result, a bank is both subject to market discipline to restrain its risk taking and, if it ignores this restraint, can fail without fear of financial contagion.

Hopefully, the commission members will see that substituting the combination of complex rules/regulations and regulatory oversight for transparency and market discipline doesn't work.  And they will conclude that reform needs to focus on bringing transparency to all the opaque corners of the financial system.