Why do bank regulators seem toothless?

Felix makes a valid observation: The problem of non-bank lenders is a huge one: most existing regulatory institutions were created to protect depositors, rather than borrowers, and as a result just about anybody can lend however much they like to whomever they like on whatever terms they like sans any real regulatory oversight at all.

The reason for this I think is that Central bank regulators have yet to catch on to the idea that banks can victimize more than just the depositor. Historically, it’s always been the depositor who was fleeced whenever a bank misbehaved. It was his money that the bank played with, and that the bank lost. The borrower , on the other hand, was someone that everyone thought could take care of himself.

When a bank provided a no-doc, no down payment loan to anyone who did not exhibit the ability to repay it at some point in time, the automatic assumption has been that that borrower must be the bank owner, one of his affiliates, or one of his cronies. He was never thought to be the ‘victim’ but a parasite instead.

We all know that the US experience shows that this is not always going to be the case. Their experience, in a society where there are more net borrowers than there are net savers, a ‘corrupt’ banker’s attentions can in fact turn towards the borrower. The pickings are just more abundant on that side of the business. And now that the we understand that the bank need not be lending its deposits when it makes loans (there are numerous ways banks can raise their loanable funds), there need not even be sufficient deposits for mass gouging of the consumer to occur.

That in turn creates a disastrous race to the bottom as banks try to compete with unregulated lenders, and in the end everybody — banks, consumers, non-bank lenders, the lot — finds themselves heaped up, broken and crumpled, in the corner (solution).

I have always wondered why the move in the US towards universal banking (allowing banks to operate both as commercial and investment banks) did not result instead, in stifling risk-taking at the investment banking arms of the unibanks. After all, if you have all these units under the same roof, they all automatically fall under the regulatory umbrella of the central bank?

So if a certain type of investment is not allowed for a commercial bank, it should automatically be disallowed for the investment banking unit. After all, it’s not hard to imagine that the ultimate backstop for any investment banking loss resulting from excessive risk-taking is always going to be the depositor. Hence, any i-bank coming under the roof of a commercial banking parent ought to have been effectively neutered of its risk-taking impulses. And any self-respecting bank examiner doesn’t even have to fully understand what it is that the i-bank is doing, because that fact of complexity alone would have raised flags immediately. He could have easily just either disallowed it, or simply counted the whole position 100% against the capital of the commercial bank (which would have immediately led to the parent disallowing the position itself).

So if you understood how unibanks are supposed to be regulated, their mere formation should have suggested to you that it leads to more investment banks competing on the same playing field, and same level, as the commercial banks.

…while non-bank lenders can act more or less with predatory impunity unless and until they grow above $10 billion in size, stealing customers from banks and gouging them freely. As for non-banks (including check cashers, payday lenders and title insurers in Felix’s argument) some central banks even put all these entities under their supervision, merely because they engage in a bank-like activity with the general public. Any sign of misbehaviour and they lose their intermediary license.

My guess is that this is easier to say than do, especially in a large capital market such as the US. But then…

And this from Joseph Stiglitz may simply be the most logical reason for the seeming toothlessness of regulation in the US. "It's time for us to reflect on our own structure today, and to say there are parts that can be improved." The core issue is that regional Fed banks, such as the New York Fed, have clear conflicts of interest -- a result of the banks being partly governed by a board of directors that includes officers of the very banks they're supposed to be overseeing.