The Decline of Traditional Banking: Implications for Financial Stabilityand Regulatory Policy

50 Pages Posted: 27 Jun 2000 Last revised: 26 Aug 2010

See all articles by Franklin R. Edwards

Franklin R. Edwards

Columbia Business School - Finance and Economics

Frederic S. Mishkin

Columbia Business School - Finance and Economics; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: January 1995

Abstract

This paper outlines the fundamental economic forces that have led to the decline in traditional banking, that is the process of making loans and funding them by issuing short-dated deposits. The declining competitiveness of traditional banking may threaten financial stability by increasing bank failures and by increasing the incentives for banks to take on more risk, either by making more risky loans or by engaging in 'nontraditional' financial activities that promise higher returns but greater risk. This paper argues that most nontraditional activities, such as banks acting as derivatives dealers, expose banks to risks and moral hazard problems that are similar to those associated with banks' traditional activities, and that these activities can be regulated as effectively as can traditional activities. One regulatory approach to maintain financial stability and strengthen the banking system is to adopt a system of structured bank capital requirements with early corrective action by regulators. An important element in this approach is that market- value accounting principles would be applied to banks and there would be increased public disclosure by banks of the risks associated with their trading activities. With this regulatory structure in place, banks could be permitted greater freedom to expand into nontraditional activities.

Suggested Citation

Edwards, Franklin and Mishkin, Frederic S., The Decline of Traditional Banking: Implications for Financial Stabilityand Regulatory Policy (January 1995). NBER Working Paper No. w4993. Available at SSRN: https://ssrn.com/abstract=226591

Franklin Edwards

Columbia Business School - Finance and Economics ( email )

3022 Broadway
New York, NY 10027
United States
(212) 854-5553 (Phone)

Frederic S. Mishkin (Contact Author)

Columbia Business School - Finance and Economics ( email )

3022 Broadway
New York, NY 10027
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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