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The Banking Crisis: Causes, Consequences and Remedies

In: Systemic Implications Of Transatlantic Regulatory Cooperation And Competition

Author

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  • Paul De Grauwe

    (University of Leuven and CESifo, Belgium)

Abstract
The paradigm that financial markets are efficient has provided the intellectual backbone for the deregulation of the banking sector since the 1980s, allowing universal banks to be fully involved in financial markets, and investment banks to become involved in traditional banking. There is now overwhelming evidence that financial markets are not efficient. Bubbles and crashes are an endemic feature of financial markets in capitalist countries. Thus, as a result of deregulation, the balance sheets of universal banks became fully exposed to these bubbles and crashes, undermining the stability of the banking system. The Basel approach to stabilize the banking system has as an implicit assumption that financial markets are efficient, allowing us to model the risks universal banks take and to compute the required capital ratios that will minimize this risk. I argue that this approach is unworkable because the risks that matter for universal banks are tail risks, associated with bubbles and crashes. These cannot be quantified. As a result, there is only one way out, and that is to return to narrow banking, a model that emerged after the previous largescale banking crisis of the 1930s but that was discarded during the 1980s and 1990s under the influence of the efficient market paradigm.

Suggested Citation

  • Paul De Grauwe, 2011. "The Banking Crisis: Causes, Consequences and Remedies," World Scientific Book Chapters, in: Simon J Evenett & Robert M Stern (ed.), Systemic Implications Of Transatlantic Regulatory Cooperation And Competition, chapter 2, pages 23-46, World Scientific Publishing Co. Pte. Ltd..
    • Handle: RePEc:wsi:wschap:9789812838490_0002
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    Cited by:

    1. Brini, Alessio & Tedeschi, Gabriele & Tantari, Daniele, 2023. "Reinforcement learning policy recommendation for interbank network stability," Journal of Financial Stability, Elsevier, vol. 67(C).
    2. Meier, Samira & Rodriguez Gonzalez, Miguel & Kunze, Frederik, 2021. "The global financial crisis, the EMU sovereign debt crisis and international financial regulation: lessons from a systematic literature review," International Review of Law and Economics, Elsevier, vol. 65(C).

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