Making Banking Safe

Stephen Cecchetti and Kermit Schoenholtz

No 18302, CEPR Discussion Papers from C.E.P.R. Discussion Papers

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; Financial regulation; Federal Reserve; Capital requirements; Liquidity requirements (search for similar items in EconPapers)
Date: 2023-07
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