Can It Be Prevented This Time?: The Role of Profits in Banking Regulation

Giuseppe Mastromatteo and Lorenzo Esposito

Economics Working Paper Archive from Levy Economics Institute

Abstract: Since the nineties, crises have punctuated financial markets, shattering the conventional wisdom about how these markets work and how to regulate them, and forcing a deep rethinking of the supervisory framework that, however, did not change much of the banks' behavior and incentives. In particular, banking regulation did not face the nexus profitability-riskiness. Based on Minsky's financial instability hypothesis, we discuss the literature on banks' profitability and its relation to the originate-to-distribute model. We also propose a different strategy for banking regulation, based on a profitability cap that prevents financial innovation from overwhelming supervision. Finally, we discuss the data for the US case, confirming the importance of profitability as a signal of incoming troubles and the possibility of using the profitability cap to greatly simplify banking regulation.

Keywords: banking regulation; financial stability; Minsky; Basel 3; profitability (search for similar items in EconPapers)
JEL-codes: G01 G28 (search for similar items in EconPapers)
Date: 2023-06
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