Optimal prudential regulation of the bank risk-taking

Procesos de Mercado: Revista Europea de Economía Política. 2022. Vol. XIX. No. 1. P. 13–62.

Penikas H. I.

The 2020 pandemic is likely to result in massive credit defaults. Regu-lators assure us that banks are sufficiently stable. However, opponents claim that regulation is lax, that it must be tightened and a supranational regulator is vitally needed. To resolve this debate, we return to the basics of the modern banking system. We analyze the evolution of micro- and macroprudential reg-ulation, particularly touching on systemic risk. We find the solution at the inter-section of von Hayek’s (1929) theory of full reserve requirement for sight deposits and Ostrom’s (2009) theory of polycentricity, which proves more effi-cient to optimally use common-pool resources. We elaborate on Selmier’s (2016) watershed-driven recommendations to govern financial markets and extend them to a traffic flow analogy. We conclude with operational recom-mendations for existing prudential banking regulation revision. We provide additional justification for the need of a full reserve system. This allows to aban-don state deposit insurance systems with chronic budget deficits.

Keywords: gold standard, regulations, traffic, Basel Committee, reserve requirement