Bank Regulation and the Resolution

of Banking Crises
Course Introduction and Overview

Contents
1
Course Objectives 3

2
The Course Author 3

3
Course Content 4

4
The Course Structure 5

5
Learning Outcomes 7

6
Study Materials 7

7
Assessment 8

 Bank Regulation and the Resolution of Banking Crises

2 University of London
 Course Introduction and Overview

1 Course Objectives
Welcome to this course, Bank Regulation and the Resolution of Banking Crises.
The course has been designed to introduce you to some of the key concepts,
principles and practices in modern banking regulation and the resolution of
modern banking crises. The literature on these subjects is vast so, in ap-
proaching the material, we will be selective, focusing on a selection of key
issues of relevance to the topic.
The link between regulation and crises has recently moved from abstract
discussion and specialists’ technical papers to popular debate and headline
news, and the regulatory objective of achieving systemic stability. The
surprising change in its status results from the widespread perception that
the systems of bank regulation carefully constructed up to 2007 failed to
achieve the objective of systemic stability; the regulators have been seen as
having been blind to the problems that were revealed by the 2007 financial
crisis, or even having had a regulatory system that contributed to the crisis.
The financial crisis that emerged in the US in early-2007 has since spread to a
number of countries, with worldwide effects on real economic activity.
In this course we will often refer to this crisis as the ‘2007 financial crisis’ as
it commenced in that year, although it continued into 2008 and took a
dramatic turn for the worse as a result of the failure of Lehman Brothers
bank in September 2008, and the resolution of the banking crisis will take
years to complete. Faults in bank regulation were not the direct or only
cause of the financial crisis, but the crisis has led policy makers and academ-
ics to attempt to restructure regulation systems so as to overcome the faults
revealed by the crisis. This course introduces some of the reform proposals
but, as debates continue, none is final.

2 The Course Author

Dr Cyrus Rustomjee is currently Director, Economic Affairs Division,
Commonwealth Secretariat and head of the Centre for Economic Training in
Africa (CETA) based in Durban, South Africa. In South Africa he has been
Chairperson of the Policy Board for Financial Services and Regulation,
which advises the Minister of Finance on all aspects of the South African
financial system; Chairperson of the Financial Services Board, which regu-
lates the country’s non-bank financial sector, and member of the Standing
Committee for the Revision of the Banks Act. He has served as Executive
Director for 21 African countries in the Executive Board of the IMF (1998–
2002). He has also been a member of the World Bank Executive Board (1996–
98); Advisor to the Deputy Minister of Finance in South Africa (1994–1996);
Corporate Bank Manager (1984–91); and Technical Expert in drafting the
financial clauses of South Africa’s new Constitution (1995/96). Dr Rustomjee
holds graduate and post-graduate qualifications in economics, law, politics,
banking and finance.

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 Bank Regulation and the Resolution of Banking Crises

3 Course Content
This course enables you to study principles of bank regulation and supervi-
sion as they have developed over many decades, and especially since the
1980s. Those principles - and illustrative examples – are intended to have
general applicability and to be able to evolve gradually to keep up with the
evolution of banking.
However, confidence in regulation and supervision was severely shaken by
the banking crisis that started in 2007 and sharply worsened in 2008 and that
crisis puts the principles and their application into sharp focus. As the
course proceeds, we will frequently reflect on the lessons of the 2007 bank-
ing and financial crisis. Unit 1 points out that the recent crisis has revealed
many weaknesses in the framework for bank regulation and has prompted
some to argue that it requires significant reform.
One issue concerns the quality of lending and the assessment of risk by
banks when lending. Clearly, banks did not consider the quality of their
mortgage lending carefully enough. Yet as we will note in Units 2 and 3,
there are in fact many formal regulations and banking supervisory practices
that banks were expected to follow and which regulators and supervisors
were expected to enforce, to ensure that banks carefully consider lending
quality and adequately assess the risks involved in lending. In the first
phase of the 2007 financial crisis, it is clear that banks and mortgage lenders
had little effective incentive to ensure sound lending and risk management
practices; their new business model of ‘originate and distribute’ meant that.
A second issue is the quality of supervision of financial institutions. Poor
supervision of bank lending activity clearly played a part in fuelling the
reckless lending which seems to have taken place across large parts of the
housing mortgage market in the US. Are there guidelines that can help bank
regulators and supervisors in their work? You will see in Unit 3 that there
are many guidelines for helping supervisors conduct their work, both in
normal times when no crisis is present, as well as in periods when banks are
weak and financially stressed.
A third issue is whether there should be safety nets to minimise failure
when banks experience liquidity problems, or minimise the effects when
banks fail through becoming insolvent. The roles that regulators, central
banks, and the state’s budget can or should have in such circumstances is
contentious and involves difficult issues such as how to judge whether a
bank is insolvent rather than being solvent but experiencing liquidity
problems. These problems are examined in Unit 4, when you will study
lender-of-last-resort facilities, typically by central banks, as well as other
forms of emergency liquidity support.
Unit 5 continues the discussion of the regulatory and supervisory treatment
of financially distressed banks by focusing on two sets of issues that occur
when a bank ultimately fails, or after it has been declared insolvent. In these
instances, the standard regulations have clearly proved inadequate to
address the banks’ financial weaknesses and to avoid insolvency. The first
issue focuses on the approach to dealing with a failed bank’s assets and

4 University of London
 Course Introduction and Overview

liabilities; the second focuses on approaches to protect depositors in the

event of failure.
A fourth theme is the structure of regulation: which institutions, at which
level – city, state or national/federal – regulate the banking sector? In
both the US and the UK regulation is fragmented between different
authorities, although the nature of the fragmentation is very different in
the two countries. But fragmented authority is not the case in most other
countries. Does the structure of regulation have an impact on the effective-
ness of regulation? And could a different regulatory framework have helped
avert the crisis? We will consider these issues in Unit 6, when we examine
regulatory structure.
A fifth issue highlighted by the 2007 financial crisis is the need for far
stronger and more effective market conduct and conduct of business
regulation. For example, the crisis highlights that the conduct of some of
the originating banks and mortgage institutions was unscrupulous and in
some instances illegal. Through their marketing strategies and their lending
practices, millions of prospective homeowners were tempted into long-term
borrowing on the strength of short-term benefits, including fee-waivers and
deferred instalment payments. But when they experienced difficulty in
meeting their instalments, huge penalty fees were imposed and they found
themselves trapped. Yet others were tempted to switch their loans on the
promise of a better deal and evidence later shows that many, including the
elderly and the vulnerable, were coerced, but unscrupulous lenders.
Unit 7 considers some of these recent challenges to financial sector regula-
tion and supervision. The regulations developed prior to 2007 represent
powerful tools for supervisors seeking to improve the condition of weak
banks. Yet these steps can only be effective if the supervisor has the power
to take such actions and if the supervisor has the capacity to enforce such
measures. In Unit 7, we will consider the various models of regulatory
structure and the implications these have for supervisory capacity
Regulation of banks’ lending to households and non-financial firms is one
thing, and it has been a regulatory issue since the beginning of regulation.
The problems for regulators thrown up by banking innovations such as
collateralised debt obligations, credit default swaps at the start of the
twenty-first century are of a different order and require different reforms.
Unit 8 examines trade-offs between competition and financial stability in
banking.

4 The Course Structure

Unit 1 Why and How Should Banks Be Regulated?
1.1 Key Objectives of Bank Regulation
1.2 Regulatory Issues Illuminated by the 2007 Banking Crisis
1.3 The 2007 Crisis – Analysis and Response by the UK Financial Regulation Body
1.4 Lessons for Regulators from the 2007 Crisis
1.5 Other Types of Bank Regulation
1.6 Conclusion

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 Bank Regulation and the Resolution of Banking Crises

Unit 2 Banking Supervision and Regulation

2.1 Key Phases in Bank Regulation (Part 1)
2.2 Regulating Bank Capital Adequacy (Part 2)
2.3 Background – The 1988 Basel Accord
2.4 The Basel II Accord
2.5 Conclusion
Unit 3 The Prudential Supervision of Banks
3.1 The Prudential Supervision of Banks
3.2 Basel Core Principles for Effective Banking Supervision
3.3 The Effectiveness of Different Supervision Approaches
3.4 Case Study – Turkey
3.5 Conclusion
Unit 4 Bank Crises – Weak Banks and Lender-of-Last-Resort Support
4.1 Introduction
4.2 Lender-of-Last-Resort Facilities (LOLR)
4.3 LOLR to Illiquid But Solvent Banks
4.4 LOLR to Illiquid, Possibly Insolvent, Banks
4.5 Recent Developments Modifying Thornton and Bagehot’s Principles
4.6 Conclusion
Unit 5 Restructuring Failed Banks and Protecting Depositors
5.1 Resolving Bank Failures
5.2 Resolving Systemic Banking Crises
5.3 Deposit Insurance
5.4 Mandates and Powers of Deposit Insurance Agencies
5.5 Public Awareness
5.6 Conclusion
Unit 6 The Institutional Structure of Financial Regulation
6.1 Approaches to Institutional Structure for Financial Regulation
6.2 Why is Regulatory Structure Important?
6.3 Regulatory Structure and the Role of the Central Bank
6.4 Two Contrasting Models of Financial Regulation – The US Regulatory System
6.5 The UK’s Financial Services Authority – Lessons from 2007–2008
6.6 Criticisms of the Single Regulatory Structure
6.7 Conclusion
Unit 7 Regulation, Supervision and Financial Stability
7.1 Financal Stability and Systemic Risk
7.2 Recent Developments in Financial Markets
7.3 Is Modern Regulation Keeping Pace with Developments in Financial Markets?
7.4 Some Policy and Institutional Responses to the 2007 Financial Crisis
7.5 Recommendations of the Financial Stability Forum
7.6 Conclusion

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 Course Introduction and Overview

Unit 8 Issues in International Supervision and Regulation

8.1 Offshore Financial Centres
8.2 Regulation, International Institutions and Standards and Codes
8.3 Proposals for International Regulatory Agencies
8.4 A World Financial Authority
8.5 An International Lender of Last Resort
8.6 Conclusions

5 Learning Outcomes
When you have completed your study of this course, you will be able to
• outline key objectives of bank regulation
• describe some of the linkages between regulation and regulatory
practice, on the one hand; and banking crises on the other
• describe in detail how the 2007 banking crisis originated in the United
States and United Kingdom, how it developed and how it escalated
through the wider financial system
• outline the major early lessons the crisis has yielded, for strengthening
banking and financial sector regulation
• explain the importance of bank capital adequacy and its relevance to
the prudential regulation of banks
• list some of the challenges arising from the original Basel I Capital
Accord
• explain the key elements of the Basel II capital adequacy framework
• describe the major components of modern bank prudential
supervision, using the financial soundness indicator and CAMELS
framework
• distinguish between lender-of-last-resort support for liquidity and
supporting the bank through investing new capital
• discuss the concept of ‘too big to fail’ and the difficulties related to it
• outline the various approaches to resolving failed banks and
managing the consequences of their failure
• highlight the key principles supporting the establishment of a deposit
insurance system
• distinguish between the various approaches used by countries, when
structuring their regulatory institutions
• outline key changes in banking and financial markets, particularly
since the mid-1990s, that have increased the prevalence of systemic
risk
• outline the main arguments for and against the establishment of a
global financial regulator.

6 Study Materials
This Study Guide is your central learning resource as it structures your
learning unit by unit. Each unit should be studied within a week. It is

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 Bank Regulation and the Resolution of Banking Crises

designed in the expectation that studying the unit and the associated core
readings will require 15 to 20 hours during the week, but this will vary
according to your background knowledge and experience of studying.

Textbooks
In addition to the Study Guide, you should read the assigned chapters in the
following report and textbooks, which are provided for you.
Financial Services Authority (2009) The Turner Review: A regulatory response to
the global banking crisis, London: Financial Services Authority
Kern Alexander, Rahul Dhumale and John Eatwell (2006) Global Governance
of Financial Systems: The International Regulation of Systemic Risk, Oxford UK:
Oxford University Press
C. Enoch, D. Marston and M. Taylor (2002) Building Strong Banks through
Surveillance and Resolution, Washington DC: International Monetary Fund.

Course Reader
The additional reading you are required to complete, in concert with your
reading of the Study Guide’s Course Units, is a selection of academic articles
and extracts from books and documents. These are provided for you in the
Course Reader. The Course Reader articles are often more technical, or
adopt a more in-depth approach on particular topics than the text of the
Study Guide. This should not put you off, as many were written with an
academic audience in mind. These articles were selected so that the central
arguments and concepts can be understood and appreciated at a level
appropriate to this course.

Optional Reading
You are provided with all the reading essential for this course, and we do
not expect you to undertake extra reading on your own, partly because not
all students have ready access to good libraries or bookshops. However, the
reference section of each unit lists academic articles, book chapters or web
based sources that you can choose to read if you wish to further investigate
a particular topic. Many of these readings can be accessed on the internet,
but it is important to note that they will not be assessed in examination or
assignments.
Although not mandatory, we think that you will enrich your study of this
course by looking at such articles. Indeed, you are encouraged to choose
your own additional reading on topics related to corporate governance. You
can do this through searching the internet and by making use of the online
academic journals through the Library resources on the CeFiMS Online
Study Centre.

7 Assessment
Your performance on each course is assessed through two written
assignments and one examination. The assignments are written after

8 University of London
 Course Introduction and Overview

week four and eight of the course session and the examination is written
at a local examination centre in October.
The assignment questions contain fairly detailed guidance about what is
required. All assignment answers are limited to 2,500 words and are marked
using marking guidelines. When you receive your grade it is accompanied
by comments on your paper, including advice about how you might im-
prove, and any clarifications about matters you may not have understood.
These comments are designed to help you master the subject and to improve
your skills as you progress through your programme.
The written examinations are ‘unseen’ (you will only see the paper in the
exam centre) and written by hand, over a three hour period. We advise that
you practice writing exams in these conditions as part of you examination
preparation, as it is not something you would normally do.
You are not allowed to take in books or notes to the exam room. This means
that you need to revise thoroughly in preparation for each exam. This is
especially important if you have completed the course in the early part of
the year, or in a previous year.

Preparing for Assignments and Exams

There is good advice on preparing for assignments and exams and writing
them in Sections 8.2 and 8.3 of Studying at a Distance by Talbot. We recom-
mend that you follow this advice.
The examinations you will sit are designed to evaluate your knowledge and
skills in the subjects you have studied: they are not designed to trick you. If
you have studied the course thoroughly, you will pass the exam.

Understanding assessment questions

Examination and assignment questions are set to test different knowledge
and skills. Sometimes a question will contain more than one part, each part
testing a different aspect of your skills and knowledge. You need to spot the
key words to know what is being asked of you. Here we categorise the types
of things that are asked for in assignments and exams, and the words used.
All the examples are from CeFiMS examination papers and assignment
questions.

Definitions
Some questions mainly require you to show that you have learned some concepts, by
setting out their precise meaning. Such questions are likely to be preliminary and be
supplemented by more analytical questions. Generally ‘Pass marks’ are awarded if the
answer only contains definitions. They will contain words such as:

Describe

Define

Examine

Distinguish between

Compare

Contrast

Write notes on

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 Bank Regulation and the Resolution of Banking Crises

Outline

What is meant by

List

Reasoning
Other questions are designed to test your reasoning, by explaining cause and effect.
Convincing explanations generally carry additional marks to basic definitions. They will
include words such as:

Interpret

Explain

What conditions influence

What are the consequences of

What are the implications of

Judgment
Others ask you to make a judgment, perhaps of a policy or of a course of action. They will
include words like:

Evaluate

Critically examine

Assess

Do you agree that

To what extent does

Calculation
Sometimes, you are asked to make a calculation, using a specified technique, where the
question begins:

Use indifference curve analysis to

Using any economic model you know

Calculate the standard deviation

Test whether
It is most likely that questions that ask you to make a calculation will also ask for an
application of the result, or an interpretation.

Advice
Other questions ask you to provide advice in a particular situation. This applies to law
questions and to policy papers where advice is asked in relation to a policy problem. Your
advice should be based on relevant law, principles, evidence of what actions are likely to
be effective.

Advise

Provide advice on

Explain how you would advise

Critique
In many cases the question will include the word ‘critically’. This means that you are
expected to look at the question from at least two points of view, offering a critique of
each view and your judgment. You are expected to be critical of what you have read.
The questions may begin

Critically analyse

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 Course Introduction and Overview

Critically consider

Critically assess

Critically discuss the argument that

Examine by argument
Questions that begin with ‘discuss’ are similar – they ask you to examine by argument, to
debate and give reasons for and against a variety of options, for example

Discuss the advantages and disadvantages of

Discuss this statement

Discuss the view that

Discuss the arguments and debates concerning

The grading scheme

Details of the general definitions of what is expected in order to obtain a
particular grade are shown below. Remember: examiners will take account
of the fact that examination conditions are less conducive to polished work
than the conditions in which you write your assignments. These criteria
are used in grading all assignments and examinations. Note that as the
criteria of each grade rises, it accumulates the elements of the grade below.
Assignments awarded better marks will therefore have become comprehen-
sive in both their depth of core skills and advanced skills.

70% and above: Distinction As for the (60-69%) below plus:

• shows clear evidence of wide and relevant reading and an engagement
with the conceptual issues
• develops a sophisticated and intelligent argument
• shows a rigorous use and a sophisticated understanding of relevant
source materials, balancing appropriately between factual detail and
key theoretical issues. Materials are evaluated directly and their
assumptions and arguments challenged and/or appraised
• shows original thinking and a willingness to take risks

60-69%: Merit As for the (50-59%) below plus:

• shows strong evidence of critical insight and critical thinking
• shows a detailed understanding of the major factual and/or
theoretical issues and directly engages with the relevant literature on
the topic
• develops a focussed and clear argument and articulates clearly and
convincingly a sustained train of logical thought
• shows clear evidence of planning and appropriate choice of sources
and methodology

50-59%: Pass below Merit (50% = pass mark)

• shows a reasonable understanding of the major factual and/or
theoretical issues involved
• shows evidence of planning and selection from appropriate sources,
• demonstrates some knowledge of the literature
• the text shows, in places, examples of a clear train of thought or
argument

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 Bank Regulation and the Resolution of Banking Crises

• the text is introduced and concludes appropriately

45-49%: Marginal Failure

• shows some awareness and understanding of the factual or theoretical
issues, but with little development
• misunderstandings are evident
• shows some evidence of planning, although irrelevant/unrelated
material or arguments are included

0-44%: Clear Failure

• fails to answer the question or to develop an argument that relates to
the question set
• does not engage with the relevant literature or demonstrate a
knowledge of the key issues
• contains clear conceptual or factual errors or misunderstandings
[approved by Faculty Learning and Teaching Committee November 2006]

Specimen exam papers

Your final examination will be very similar to the Specimen Exam Paper that
you received in your course materials. It will have the same structure and
style and the range of question will be comparable.
CeFiMS does not provide past papers or model answers to papers. Our
courses are continuously updated and past papers will not be a reliable
guide to current and future examinations. The specimen exam paper is
designed to be relevant to reflect the exam that will be set on the current
edition of the course

Further information
The OSC will have documentation and information on each year’s
examination registration and administration process. If you still have
questions, both academics and administrators are available to answer
queries.
The Regulations are available at [Link]/[Link],
setting out the rules by which exams are governed.

12 University of London
 Course Introduction and Overview

UNIVERSITY OF LONDON
Centre for Financial and Management Studies
MSc Examination
MBA Examination
Postgraduate Diploma Examination
for External Students
91DFMC356
FINANCE
BANKING

Bank Regulation & Resolution of Banking Crises

Specimen Examination

This is a specimen examination paper designed to show you the type of examination
you will have at the end of the year for Bank Regulation & Resolution of
Banking Crises. The number of questions and the structure of the examination
will be the same but the wording and the requirements of each question will be
different. Best wishes for success in your final examination.

The examination must be completed in THREE hours. Answer THREE questions.

The examiners give equal weight to each question; therefore, you are advised to
distribute your time approximately equally between three questions

PLEASE DO NOT REMOVE THIS PAPER FROM THE EXAMINATION ROOM.

IT MUST BE ATTACHED TO YOUR ANSWER BOOK AT THE END OF THE
EXAMINATION.

© University of London, 2009 PLEASE TURN OVER

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 Bank Regulation and the Resolution of Banking Crises

Answer THREE questions.

1. Explain the key regulatory issues arising from the banking crisis,
which started in 2007, and discuss the key lessons learned by
bank regulators.

2. Write an essay explaining the importance of bank capital

adequacy and its relevance to the prudential regulation of
banks. Illustrate your answer with reference to the Basel Capital
Accords.

3. Describe the CAMELS framework for the prudential supervision

of individual banks.
Illustrate your answer with reference to country examples.

4. Explain how bank supervisors address the challenges posed by

banks that are weak but not facing financial distress.

5. “Most countries have established deposit insurance systems

because the benefits are obvious and the systems are easy to
design and implement”.
Critically discuss this statement.

6. Compare and contrast fully unified and other models of regula-

tory structure. Which model is best equipped to address systemic
risk and financial stability?

7. “The financial crisis from 2007 has shown that bank regulators
are well-equipped to adapt to changes in financial markets and
can effectively address systemic risk and threats to financial
stability”.
Discuss this statement.

8. Describe the advantages offered and the challenges posed by

offshore financial centres

[END OF EXAMINATION]

14 University of London
Bank Regulation and the Resolution
of Banking Crises
Unit 1 Why and How Should Banks
Be Regulated?

Contents
1.1 Key Objectives of Bank Regulation 3

1.2 Regulatory Issues Illuminated by the 2007 Banking Crisis 6

1.3 The 2007 Crisis – Analysis and Response

by the UK Financial Regulation Body 7

1.4 Lessons for Regulators from the 2007 Crisis 8

1.5 Other Types of Bank Regulation 13

1.6 Conclusion 14

References and Websites 14

 Bank Regulation and the Resolution of Banking Crises

Unit Content
This introductory unit has been divided into three parts. We start by dis-
cussing the rationale for and the major objectives of banking regulation. We
will refer to these throughout this course. Secondly, we examine how both
parts of the course’s subject matter – banking regulation and banking crises
– are closely linked, with bank regulators responding to banking crises with
new approaches to regulation.

Learning Objectives
By the time you have completed Unit 1, you can expect to be able to:
• outline key objectives of bank regulation
• describe some of the linkages between regulation and regulatory
practice, on the one hand; and banking crises on the other
• describe in detail how the 2007 banking crisis originated in the United
States and United Kingdom, how it developed and how it escalated
through the wider financial system
• outline the major early lessons the crisis has yielded, for strengthening
banking and financial sector regulation
• discuss the major regulatory steps being considered to try to avoid a
repeat of the circumstances that have brought about the current crisis.

Reading for Unit 1

Course Reader
Mathias Dewatripont and Jean Tirole (1994) ‘The Nature of Banking and
the Rationale for Regulation’, in Dewatripont and Tirole, The Prudential
Regulation of Banks, Cambridge, MA: MIT Press

Report
Financial Services Authority (2009) The Turner Review: A regulatory response
to the global banking crisis, London: Financial Services Authority

2 University of London
 Unit 1 Why and How Should Banks Be Regulated?

1.1 Key Objectives of Bank Regulation

Bank regulation has, until recently, been a subject for specialists. The general
public and even most economists have given little thought to the work of
bank regulators, perhaps seeing them as specialists working within a closed
circle on a worthy but obscure and uninteresting task. The crisis of 2007 has
changed that and thrust bank regulation into the limelight. Public debate has
revolved loudly around basic questions: Was the regulation system in the
United States, the United Kingdom and elsewhere fundamentally flawed?
Were regulators themselves asleep on the job? How could changes in
regulation prevent future crises?
If we take a step back from the headline questions, a more basic question
becomes apparent. Before we can consider whether regulation failed and
how it should be reformed, we have to ask what regulation is for:
• What are the objectives of bank regulation?
Or, more fundamentally:
• Why does bank regulation exist?

 Exercise
Please pause briefly and reflect on those questions. Try to make a note of the reasons you
would give for bank regulation to exist, or of the objectives you think it should have.

Nowadays it is commonly accepted that some form of bank regulation is

needed, but regulation needs to be justified; over the centuries several
arguments against regulating banks have surfaced.
Today the main issues derive from the fact that banking involves several
types of risk, and the main debates concern regulation of risk taking. That is
known as prudential regulation and is the subject of most of this course. Later
in this unit we shall describe some other types of banking regulation, too,
but let us keep focused on prudential regulation for now. The risks banks
face include these three types, and others:
• Credit risk – the risk of default by borrowers (which would give
rise to losses through having non performing loans on the bank’s
balance sheet)
• Interest rate risk – the risk that interest rates received on assets and paid
on liabilities might move in unexpected directions
• Market risk – the risk of a decline in the market values of a bank’s
assets such as foreign currency and derivatives.
Any risk such as those could lead to losses so large that the bank fails, enters
bankruptcy and is liquidated – and, in fact, bank failures do regularly occur
in many countries even when banking as a whole is not in crisis.
A failure of an individual bank usually causes losses to
1 the shareholders,

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 Bank Regulation and the Resolution of Banking Crises

2 holders of the bank’s debt, and

3 depositors.
We could extend the list to include bank employees, borrowers from the
bank who are unable to renew their financing routinely, and others, but let
us stick with the three types we have identified, all of whom lose because
they own forms of bank liabilities.
In your response to the question above you might have answered that banks
should be regulated in order to control the degree of risk they take because
society should protect people from the risk of losing all. But let us reflect on
that.
It is unlikely that you would argue for the protection of shareholders, for, in
principle, modern capitalism rests on the legal rule that holders of common
stock or equity invest their money in the knowledge that they are the first to
bear loss in the event of bankruptcy. Generally, that accords with most
people’s ethical judgements too, although its fairness is arguable if shares
are held by a managed pension fund, insurance company or other institution
on behalf of small savers who have imperfect information and no effective
control over investment decisions.
It is also unlikely that you would argue for regulators to protect holders of a
bank’s debt (bonds and other securities) from the risk of a bank’s bank-
ruptcy. One reason is that they may be assumed to be sophisticated and
informed investors who have invested in those instruments at a price (or,
inversely, interest yield) that compensates them for taking the risk which
they have calculated.
However, you might have argued that regulation is required to protect the
holders of small (retail) deposits. That is generally recognised to be an
important reason and objective for regulation, for small depositors do not
have the information on which to judge a bank’s riskiness, nor do they have
an incentive to acquire the information or the skills to be able to judge it.
Let us agree that the protection of small depositors is one principal reason for
regulation – the regulators act as their ‘representatives’. At the end of
Section 1.1 we will suggest that you read an article by Dewatripont and
Tirole which presents reasoned arguments in favour of that view as well as
discussing criticisms of that view.
The idea that regulation exists to protect small depositors is usually framed
in terms of the regulation of a single bank. But in the wake of the 2007 crisis,
which went on to affect whole banking systems, other financial institutions
and financial markets, your answer to that question might have focused on
the broader system rather than an individual bank.
From that point of view, a second principal reason for bank regulation is the
systemic effect that a bank’s failure might have. Regulators should oversee
banks’ riskiness in order to prevent the failure of an individual bank damag-
ing the financial system as a whole. And from that perspective – a view that
has been strengthened by the 2007 crisis – is that bank regulation and
supervision should occur within a framework that takes account of the
riskiness of the financial system as a whole.

4 University of London
 Unit 1 Why and How Should Banks Be Regulated?

Some might argue that those two reasons are not sufficient to justify or
explain the regulation of banking, for similar reasons could (at a stretch) be
put forward for regulating some industrial firms, yet they would not be
convincing for non-financial firms. Why not regulate a car firm’s financial
behaviour? Its collapse would directly or indirectly damage thousands of
small suppliers who could not have been expected to monitor the firm’s
financing, and its collapse might cause other car manufacturers in that
country to suffer severely as a result of reputational damage to that coun-
try’s industry. What makes banks special?

1.2.1 Why are banks special?

The most widely accepted answer is that banks are special because their
financial services are central to the whole economy and the collapse of a
major bank or of many banks would have severe repercussions across the
economy. In particular, bank deposits are the main element of a country’s
stock of money, and the stock of money has a relation with economic ac-
tivity – albeit a complex relation, the nature of which is contested. In a
classic book published in 1963 Milton Friedman and Anna Schwartz argued
that in the United States bank failures that reduced the stock of money,
rather than the 1929 stock market crash, were a major cause of the Great
Depression of the 1930s.
Now that we have discussed the reasons for prudential regulation we would
like you to read an authoritative academic article on the subject by Mathias
Dewatripont and Jean Tirole, two economists who have led modern think-
ing on regulation of all types. The article is, in fact, based on a prestigious
lecture given in 1992 at the University of Lausanne and although it is now
many years since its publication – and the world has experienced at least
two great financial system crises since then – it provides a classic discussion
of principles which still apply.
When you read the article you might note three things. The article was
prompted by then recent crises, for the 2007 crisis was not the first big
banking crisis of modern times. In an Introduction to the reading De-
watripont and Tirole (1994: 2–3) wrote:
…renewed interest in academe for banking regulation (or deregulation)
was generated by the large-scale banking problems experienced by many
countries. For most of the World War II era bank regulation proceeded
smoothly: Few failures occurred, and the topic was not of widespread
interest to academics and to the public. Due to a number of factors…
bank failures became more common in the 1980s. The impact of the
recent banking crises on the taxpayers will often be tough. It is, for
example, estimated that the U.S. government will spend hundreds of
billions of dollars…cleaning up the [Savings and Loans, ‘thrift’
institutions] and commercial banks’ wreckage. Nordic countries have
spent $16 billion propping up their banks from 1989 through 1992…
Japan is now searching [for] remedies for its banking crisis…A number of
Latin American countries…supply yet another illustration of the extent of
banking crises they experienced in the 1980s large scale bank failures that
led to (at least temporary) nationalization of many of their largest banks.

The authors provide a simplified outline of a typical bank’s balance sheet

and its income statement. And in that context they discuss the different
elements of banks’ business. Because they were writing more than a decade

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 Bank Regulation and the Resolution of Banking Crises

before the banking boom of the early twenty first century which spawned
the 2007 crisis they do not discuss the new types of business that have been
implicated in that crisis. You will read about those new types of bank
business later in this unit.

Reading Mathias Dewatripont

and Jean Tirole (1994)
‘The Nature of
Please read Dewatripont and Tirole’s article on banking and regulation now. Banking and the

 While reading it, make notes of the arguments the authors give for and against
rationale for
Regulation’, reprinted
in the Course Reader
particular rationales for regulation. from The Prudential
Regulation of Banks.
Note that the data given in their Tables 2.3 through 2.5 can be ignored, for they are now
relevant only for historians.

1.2.2 The state as ultimate guarantor

In the wake of the crisis of the US and UK banking systems which began in
2007, we would emphasise one reason for bank regulation more than we
might have done in 1994 when Dewatripont and Tirole’s paper was pub-
lished. The current crisis has demonstrated that, in a systemic breakdown,
the state is the ultimate guarantor of the banking system. As it demonstrated
as the recent crisis worsened, the state will not allow the system to fail
because of its economic and social importance, and many individual banks
within it are considered to be so large and important for the system that they
individually warrant the state’s acting to prevent their failure, by injecting
state funds as liquidity, or as capital, or taking over their ownership – the
‘too-large-to-fail’ banks.
If the state is the ultimate guarantor, this means that the state ultimately
bears the banks’ risks. Since, in normal times, the banking system is only
able to operate because it has that implicit guarantee behind it, the state
as the ultimate bearer of the system’s risks should have the means to regu-
late banks’ risky behaviour. That is a powerful argument for regulation.
Please note, however, that it does not itself define the objectives of regula-
tion, or the detailed rules or institutional system of regulation, and it does
not by itself recognise that regulation may be ineffective and, even if effec-
tive, is costly.

1.2 Regulatory Issues Illuminated by the 2007 Banking

Crisis
The course has been written in the midst of a global banking and financial
crisis. The crisis commenced in the US from early 2007 and quickly spread to
other parts of the US financial sector. Subsequently, it spread to the banking
sectors of the UK and several European countries and caused a major
disruption in global credit markets – effectively, major financial markets
ceased to function for a period and for a significant period operated only
with dysfunctionally high risk premiums. As the crisis deepened, the inter-
bank market, on which major banks relied to access a large share of their

6 University of London
 Unit 1 Why and How Should Banks Be Regulated?

financing, and which provides the liquidity needed to maintain the pay-
ments system, broke down. Participants in this market withdrew lending to
their peer banks and forced immediate and massive intervention by the
authorities to inject liquidity into the banking system.
Inter-bank lending declined for two broad reasons:
• firstly, fears by banks that their peers had been deeply affected by the
crisis and that lending to them might therefore be risky
• secondly, all of the large banks that are key participants in the US
inter-bank market were affected by the crisis; and many required
urgent and immediate sources of additional funding to bolster their
own liquidity and also their capital base.
With large parts of the financial system affected, the sources of funding for
capital have narrowed, with those providing capital being called upon by
banks, insurance companies, pension funds, hedge funds and many others.
As a consequence, the cost of capital increased, with both developments
putting further pressure on the weakened financial institutions’ balance
sheets and also initially raising the cost of capital for industry or, in a classic
credit crunch, denying credit to industry. The repercussions were felt in
declining world trade and falls in many countries’ Gross Domestic Product
in 2008 and 2009.
It would be a convenient – and indeed stimulating – start to a course on
banking sector regulation and the resolution of banking crises to be able to
say at the very beginning that you are studying banking crises and banking
regulation at a particularly interesting, but unique, period in modern his-
tory. In part, that is correct, as the recent turmoil did rapidly call into
question many previously established practices and principles of banking
conduct. But in part, it is also not. For in this context it is an inconvenient
reality that banking sector crises and the responses to these crises, by bank-
ing sector regulators, are as old as the practice of banking itself. And while
many rules, regulations, practices and principles of banking may alter when
the current crisis has run its full course, a very much larger proportion will
remain.

1.3 The 2007 Crisis – Analysis and Response by the UK

Financial Regulation Authorities
The many failures of large banks, famous names which have disappeared,
kept alive only with government funding, or been forced into acquisition by
stronger banks – Bear Stern, Lehman Brothers, Northern Rock, Royal Bank
of Scotland, Citigroup, Countrywide, Fannie Mae, Freddie Mac are only the
best known – make one conclusion about the 2007 crisis inescapable: it
shows that prudential regulation of banking in the years preceding the crisis
had failed. ‘Failed big time!’ as a New York bank employee might say.
To say that the crisis which started in the United States and United Kingdom
in 2007 shows that the system of prudential regulation in those countries, or
internationally had failed does not mean that the faults in those systems
were the cause of the crisis. In order to discuss how bank regulation should

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 Bank Regulation and the Resolution of Banking Crises

be reformed in order to avoid similar crises it is important to consider what

the causes of the crisis were. Bank regulators, as well as other public bodies,
politicians, academics and others, responded to the crisis by rapidly at-
tempting to analyse its causes. In this section we would like you to read the
study presented by Adair Turner who, in the wake of the crisis, was ap-
pointed to head the United Kingdom’s regulatory body, the Financial
Services Authority. We have provided his study, The Turner Review, for you.

Reading Financial Services

Authority (2009) The
First we would like you to read Chapter 1 of The Turner Review, entitled ‘What went Turner Review: A
wrong?’ It presents an analysis of the causes of the crisis which is representative of the regulatory
response to the
consensus opinion that had formed by early 2009. global banking

 While reading it, we hope you will note its basic idea that the causes of the banking crisis, Chapter 1
‘What went wrong?’

crisis are to be found in the nature of the boom that preceded it. That leads to further
questions which we would like you to think about and try to answer from your reading:
• How important were macroeconomic imbalances in contrast to banks’ own
decisions for the crisis that started in 2007?
• What were the main macroeconomic imbalances in the boom years?
• What were the main changes in banks’ business model – the way that they handled
loans and the risk on them – in the years preceding the crisis?
• What was the relative importance of each of the following banking innovations in
the years leading up to the crisis:
• sub-prime mortgages
• securitisation using collateralised debt obligations
• structured investment vehicles – SIVs (or conduits)
• credit default swaps?
• What were the faults in banks’ own estimates of risk?
• How did the system of prudential regulation banking innovations create incentives
for banks to innovate in order to minimise the costs of meeting regulatory
requirements?

1.4 Lessons for Regulators from the 2007 Crisis

The crisis, which began in 2007, quickly led to intense debate about how
systems of bank regulation should be changed to minimise the risk of future
system-wide banking crises. As this course is being written, it is too early to
say what precise changes will result, but we can put forward several lessons
that have been drawn. First, we shall outline some of the lessons that we
identify as important; then we shall ask you to read Chapter 2 of The Turner
Review for the lessons and proposals which Adair Turner has focused on.
One trigger for the crisis lay at the heart of banking, even the most tradi-
tional type of banking – it was the way in which loans, such as mortgages,
are assessed, originated, and financed. Oversight falls within the remit of
regulators and supervisors, so what lessons can they learn from the sub-
prime lending that triggered the crisis?

8 University of London
 Unit 1 Why and How Should Banks Be Regulated?

One concerns the quality of lending and the assessment of risk by banks
when lending. Clearly, banks did not consider the quality of their mortgage
lending carefully enough. Yet as we will note in Units 2 and 3, there are in
fact many formal regulations and banking supervisory practices which
banks are expected to follow and which regulators and supervisors are
expected to enforce, to ensure that banks carefully consider lending quality
and adequately assess the risks involved in lending. In the first phase of the
2007 financial crisis, it is clear that banks and mortgage lenders had little
effective incentive to ensure sound lending and risk management practices;
their new business model of ‘originate and distribute’ meant that.
A second issue is the quality of supervision of financial institutions. Poor
supervision of bank lending activity clearly played a part in fuelling the
reckless lending which seems to have taken place across large parts of the
housing mortgage market in the US. Are there guidelines that can help bank
regulators and supervisors in their work? We will see in Unit 3 that there are
many guidelines for helping supervisors conduct their work, both in normal
times when no crisis is present, as well as in periods when banks are weak
and financially stressed.
A third issue is whether there should be safety nets to minimise failure
when banks experience liquidity problems, or minimise the effects when
banks fail through becoming insolvent. The roles that regulators, central
banks, and the state’s budget can or should have in such circumstances is
contentious and involves difficult issues such as how to judge whether a
bank is insolvent rather than being solvent but experiencing liquidity
problems. The problems are examined in Unit 5, when we study lender-of-
last-resort facilities, typically by central banks, as well as other forms of
emergency liquidity support; and when we consider deposit insurance, or a
safety net arrangement for individual depositors affected by financial crises.
A fourth theme is the structure of regulation: which institutions, at which
level – city, state or national/federal – regulate the banking sector? In both
the US and the UK regulation is fragmented between different authorities,
although the nature of the fragmentation is very different in the two count-
ries. But fragmented authority is not the case in most other countries. Does
the structure of regulation have an impact on the effectiveness of regulation?
And could a different regulatory framework have helped avert the crisis?
We will consider these issues in Unit 6, when we examine regulatory struc-
ture.
A fifth issue highlighted by the 2007 financial crisis is the need for far
stronger and more effective market-conduct and conduct-of-business
regulation. For example, the crisis highlights that the conduct of some of the
originating banks and mortgage institutions was unscrupulous, and in some
instances illegal. Through their marketing strategies and their lending
practices, millions of prospective homeowners were tempted into long-term
borrowing on the strength of short-term benefits, including fee-waivers and
deferred instalment payments.
But when they experienced difficulty in meeting their instalments, huge
penalty fees were imposed and they found themselves trapped. Yet others
were tempted to switch their loans on the promise of a better deal, and

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 Bank Regulation and the Resolution of Banking Crises

evidence later shows that many, including the elderly and the vulnerable,
were coerced, but unscrupulous, lenders. What role do regulators and
supervisors have in ensuring sound market conduct? And what role is there
for consumer protection in the financial services sector – and who should
guide and govern this? We will examine some useful supervisory guidelines
in Unit 3, which addresses market conduct regulation.
Regulation of banks’ lending to households and non-financial firms is one
thing, and it has been a regulatory issue since the beginning of regulation.
But the problems for regulators thrown up by banking innovations such as
collateralised debt obligations, credit default swaps at the start of the
twenty-first century are of a different order and require different reforms.
Today much debate over reform concerns improvements to the require-
ments for banks’ capital adequacy – regulatory capital. We will examine
why banks are required to maintain regulatory capital, in Unit 2, in con-
siderable detail. And we will consider how regulatory standards for capital
provisioning have evolved in the past two decades. The recent, crisis
spurred, since mid-2008, new global efforts to strengthen capital adequacy
of banks. And in Unit 2, we will examine closely the proposed content of the
proposals that have been discussed for strengthening capital adequacy
among banks all over the world.
A more fundamental modern debate focuses on the capacity of banks and
the financial engineering experts within them to innovate. It concerns the
role of regulation in balancing two competing forces:
• the need to protect the financial system from undue or uncalculated
risks, and
• the need to allow the financial sector to innovate and grow.
It was widely believed before the crisis that innovation and growth in the
financial sector promoted growth across the broader economy and therefore
regulation should occur in ways that do not restrict it. In the light of the
crisis many writers would qualify that view, and argue that only certain
types of innovation might stimulate economic growth and regulation should
occur in such a way as to permit such ‘good’ banking development. Both the
debate over capital adequacy regulations and that over the desirability or
undesirability of regulations that restrict innovation refer to the fact that
regulation of any kind imposes direct and indirect costs both on the banks
and on society. Consequently, although a crisis is often followed by a
political and popular demand for more and better regulation, it is necessary
to balance the potential benefits against the costs when assessing regulatory
reform.
From your reading about innovation in Chapter 1 of The Turner Review you
have seen that through securitisation banks had transformed mortgages into
asset-backed securities. Through this process, they were able to shift key
risks to other parties, including the risk of default by homeowners on their
mortgages, as well as the risk that the value of the collateral would collapse.
Shifting these risks may in itself not be hazardous; but if those acquiring the
risks do not understand the investments they are purchasing and do not
understand – or are not capable of assessing the risks that underlie them –

10 University of London
 Unit 1 Why and How Should Banks Be Regulated?

new sources of risk to financial stability can emerge. The transactions which
appeared to be good for an individual bank because they transfer risk to
other willing holders of the risk turned out to have increased the risk to the
financial system as a whole (and, in fact, in several cases proved not to have
removed the risk from the original bank). Regulation which seeks to ensure
that the process of risk transfer is adequately assessed by both parties, based
on sufficient and readily available information, is widely agreed to be
necessary now, although its design involves difficult challenges. Here is an
outline list of some of the challenges:

Understanding the risks

Firstly, the complexity of the collateralised debt obligation (CDO) derivative
products had made it almost impossible for all but the most sophisticated
investors to understand the risks they were assuming when investing in a
CDO. In the absence of effective regulation, there was no incentive for CDO
underwriters to disclose who had invested in CDOs, or the tranches in
which they had invested.

Transparency in risk pricing

Secondly, in the absence of regulations requiring comprehensive disclosure
of information about the nature and types of risks being assumed, there was
also no incentive to explain how risks had been priced. And in the absence
of regulation there was no compulsion on the CDO underwriters to high-
light the types of risk investors were assuming. In hindsight, as is now being
proposed by regulators and global regulatory agencies, after some US$ 500
billion in losses, far-strengthened regulation of complex structured products
such as CDOs is considered to be urgent and necessary, to better serve both
the manufacturers of these products, as well as investors, and to reduce
uninformed risk taking.

Adequate regulatory capital

Thirdly, the creation of CDOs and bank SIVs highlights the explicit
efforts by banks to avoid regulatory capital. The housing of substantial
investments, with very real risks, in SIVs, allowed the banks to avoid regula-
tory capital provisions. Once the crisis hit, many banks were forced to bring
these SIVs back on balance sheet, not because they were legally obliged to
do so – for they were separate legal entities supposedly with no responsi-
bility to each other – but because banks feared that the reputational risk if
they abandoned their SIVs would cause them far greater losses. Strength-
ened regulation, it is now argued, is required to ensure that both the on-
balance-sheet and off-balance-sheet activities of banks are fully disclosed
and that adequate regulatory capital, assessed separately for each type
lending instrument and attendant risk, is provided for both sets of activities.

Ratio of risk assumed to the capital provided

Fourthly, the establishment of synthetic CDOs or insurance contracts for
specific forms of risk, significantly raised leverage – or the ratio of risk
assumed to the capital provided – in the US financial system, and high-
lighted the ease with which new leverage can be created and the ease with
which risks can be originated and sold on to unsuspecting investors. The

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 Bank Regulation and the Resolution of Banking Crises

origination for sale of synthetic CDOs also highlights the gap between
financial innovation and the ability of regulators to keep pace with and
address the regulatory challenges posed by innovation – and, indeed,
signals the possibility that this gap has significantly, and possibly perma-
nently, widened.

Reading Financial Services

Authority (2009) The
Turner Review: A
Now please read Chapters 2 and 3 of The Turner Review. regulatory

 Compare Turner’s approach to reforms of the regulatory system with the elements
response to the
global banking
crisis, Chapter 2
we have listed in this section. ‘What to do’ and
Chapter 3 ‘Wider
issues – open
The reforms suggested by Turner, including those that the United King- questions’.

dom’s Financial Services Authority had instituted before publication, are

one regulator’s response to the needs highlighted by the crisis. Other writers
and policy makers – and various banks and banking organisations them-
selves – have their own perspectives, which partly coincide with Turner’s
and partly diverge. For the present, your main task has been to compare
Turner’s views on reforms with the reform needs we have listed.
We hope you identified one major difference between the reforms con-
sidered by Turner and those we have listed. Turner gives great emphasis to
developing systemic regulation and supervision, as compared with the
points we discussed concerning regulation and supervision of individual
banks. Regulation of individual banks to control their riskiness was the
principle behind traditional bank regulation, but, in line with the analysis of
the causes of the crisis that you read in Chapter 1 of The Turner Review,
Turner believes that regulators must deal with systemic risk.
Moreover, that includes a concern with the effects on the activity of firms
and households – the ‘real economy’ – for prudential regulation itself has
been shown to have a potentially pro-cyclical effect, as prudential capital
requirements on banks can lead to a feedback which heightens a ‘real
economy’ boom and worsens a downturn. Turner discusses proposals for
changing the system of capital adequacy requirements to prevent that pro-
cyclical feedback effect.
Turner’s concern with systemic and macroeconomic effects complements
rather than replaces attention to ‘micro’ matters – the detailed reform of
prudential regulation governing the riskiness of individual banks. You are
likely to have noted the attention that Turner gives to new approaches to
three important issues:
• the significance of common equity in regulatory (risk-weighted capital
adequacy)
• the problem of risk attached to derivatives and other items recorded in
the bank’s trading book, and
• the possibility of regulators influencing remuneration schemes of bank
employees to ensure that the design of bonus schemes and other
elements do not create incentives for taking excessive risk.

12 University of London
 Unit 1 Why and How Should Banks Be Regulated?

1.5 Other Types of Bank Regulation

In this unit we have concentrated upon one type of regulation, prudential
regulation, which is concerned with banks’ riskiness. Prudential regulation is
at the forefront of modern regulatory concerns and the principal subject of
this course, but there are other types of regulation which complement it.
One is regulation and supervision of banks’ business conduct and market
conduct. That seeks to ensure that the behaviour of supervised institutions is
consistent with the other objectives of banking supervision, including
prudential regulatory and supervisory objectives.
Examples of market conduct and conduct of business regulation include the
regulatory requirements for proper disclosure of information regarding
bank lending, ensuring that bank management possess the necessary skills
to manage the deposits of individual members of the public and of institu-
tional investors and that the systems and practices used by the bank are
sound. The soundness of bank practices incorporates the soundness of
banks’ behaviour in selling their products to retail\customers, and ensuring
that customers for various types of deposits and loans are not the subject of
unfair trading practices.
Although the core of this course is focused on prudential regulation, we will
examine various aspects of business and market conduct regulation as we
progress through the course, particularly in Units 3 and 4, for it comprises
an important part of the overall framework for banking regulation; as we
noted earlier, it can be argued that the expansion of sub-prime mortgages,
which proved to be systemically risky, was often based upon selling in an
unfair way to ill-informed households. And in Unit 6, when examining
institutional arrangements for regulation, we will note that some countries
place business and market conduct regulation in a separate regulatory
institution, while others combine this set of responsibilities, as well as
prudential regulation, in a single regulatory institution.
Other regulations are not concerned with banks’ risk or banking practices as
such, but address other economic and social concerns. Examples include
regulations requiring financial institutions to maintain a physical presence
in relatively poor areas, or to provide a minimum level of finance for hous-
ing or other sectors.
An example in the United States is Community Reinvestment Act of 1977,
which requires banks to lend without discrimination; it was especially
designed to curb discrimination against borrowers in so-called ‘bad’ or ‘red-
lined’ areas. Other regulations with social objectives require certain mini-
mum safety nets for small depositors and investors whose loss of deposits
and investments may prove catastrophic to them when financial institutions
fail. Further regulations with social objectives are those requiring banks to
cooperate in preventing money laundering by criminals and political out-
casts. We will not examine this collective set of objectives further in this
course, although we will examine some specific elements in Unit 5, includ-
ing the provision of financial safety nets that are designed to protect certain
categories of investors and depositors.

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 Bank Regulation and the Resolution of Banking Crises

1.6 Conclusion
In this unit you have studied some of the major issues concerning bank
regulation. For much of the unit we have placed these issues in the context
of the banking crisis which began in 2007, for, since the crisis represents a
major failure of regulation, it highlights the character of bank regulation and
it has stimulated renewed interest in reform of regulation. However, regula-
tion is important in ‘normal’ times when banks are operating smoothly and
the difficult questions about regulation are relevant whether or not the
system is in crisis.
In the remaining units of the course we shall be examining detailed aspects
of regulation and supervision and considering them both in the context of
crises and in contexts when bank distress is only a potential future danger.

References and Websites

Dewatripont M and J Tirole (1994) ‘The Nature of Banking and the Rationale
for Regulation’, in Dewatripont and Tirole, The Prudential Regulation of Banks,
Cambridge, MA: MIT Press, 13-45; website:
[Link]
Financial Services Authority (2009) The Turner Review: A regulatory response to
the global banking crisis, London: Financial Services Authority, March, Web-
site: [Link]/
Friedman M and AJ Schwartz (1963) A Monetary History of the United States
1867–1960, Princeton, NJ: Princeton University Press, 299–407.

14 University of London