Banking Regulation and Knowledge Problems
31 Pages Posted: 21 Jan 2016
Date Written: January 19, 2016
The Federal Reserve regulates U.S. commercial banks using a system of risk-based capital (RBC) regulations based on the Basel Accords. Unfortunately, the Fed’s misrating of several assets such as mortgage-backed securities encouraged the build-up of these assets in the banking system and was a major contributing factor to the 2008 financial crisis. The Basel system of RBC regulation is a prime example of a Hayekian knowledge problem. The contextual, tacit, and subjective knowledge required to properly assess asset risk cannot be aggregated and utilized by regulators. An effective system of banking regulation must acknowledge man’s limited knowledge and place greater value on individual decisions than on top-down planning.
Keywords: Federal Reserve, Basel Accord, Risk-based capital, Knowledge problem
JEL Classification: G18, E58, P50
Suggested Citation: Suggested Citation