Making Banking Safe

30 Pages Posted: 25 Jul 2023

See all articles by Stephen G. Cecchetti

Stephen G. Cecchetti

National Bureau of Economic Research (NBER); Brandeis International Business School; Centre for Economic Policy Research (CEPR); European Systemic Risk Board

Kermit L. Schoenholtz

New York University - Stern School of Business - Department of Economics

Date Written: July 18, 2023

Abstract

Following the bank failures of 2023, what should be done to make the financial system safe? We draw two key lessons from the recent episode: first, a banking system that relies heavily on supervisory discretion is unlikely to be resilient; second, authorities with emergency powers to bail out banks during a panic cannot credibly commit to refrain from doing so. The only way to address these challenges is to have a rigorous framework focused on crisis prevention.

To meet this goal, we argue that regulation should be more rule-based (less reliant on supervisory discretion); simpler and more transparent; stricter and more rigorous; and more efficient in its use of resources. Applying these principles to a range of proposals, we identify reforms that best address the glaring deficiencies made so clear by recent events: namely, increase capital and liquidity requirements; shift to mark-to-market accounting; and improve the transparency, flexibility and severity of capital and liquidity stress tests.

Keywords: Financial stability, Regulation, Supervision, Resolution, Federal Reserve, Federal Deposit Insurance Corporation, Stagflation, Stress Test, Federal Home Loan Banks, Capital requirements, Liquidity requirements, Liquidity risk, Systemically important markets

JEL Classification: G21, G28

Suggested Citation

Cecchetti, Stephen G. and Cecchetti, Stephen G. and Schoenholtz, Kermit L., Making Banking Safe (July 18, 2023). Available at SSRN: https://ssrn.com/abstract=4513903 or http://dx.doi.org/10.2139/ssrn.4513903

Stephen G. Cecchetti (Contact Author)

Brandeis International Business School ( email )

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National Bureau of Economic Research (NBER) ( email )

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Centre for Economic Policy Research (CEPR) ( email )

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European Systemic Risk Board ( email )

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Kermit L. Schoenholtz

New York University - Stern School of Business - Department of Economics ( email )

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Suite 7-89
New York, NY 10012
United States
212-998-0868 (Phone)

HOME PAGE: http://w4.stern.nyu.edu/faculty/bio/kim-schoenholtz

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