Good banking practices

Policy Study

Background

Banks lie at the heart of financial systems to the extent that without banking infrastructure in place capital markets, insurance and asset managers would not be functional. The rapid growth of the non-bank parts of the financial system including ‘shadow banks’ had taken attention away from banks but the financial crisis which has affected banking systems the world over had focussed minds once again on the critical nature of banking systems.

This is thus a good time to ask ourselves the questions
· what makes a good banking system
· what lessons has the crisis taught us about the problems we might have with our current system
· how might we improve the banks and the banking systems we have

Many commentators have pointed fingers at the complexity of products such as CDOs and CLOs, the non transparent nature of derivative securities, the risky nature of the shadow banking system and a host of other problems as the proximate causes for the financial crisis. Each of these criticisms is valid to some extent but must not distract us from the truth that this not the first banking crisis but closer to the hundredth one. Had CDOs and CLOs and the shadow banking system would not have existed, we would still be prone to banking crisis. So while it is important to learn lessons specific to this crisis we must not lose sight of the broader picture which clearly says that banking is a fragile business.

The policy measures we look at to improve our banking systems must tackle this bigger issue of the inherent fragility of the banking system together with the specific causes of the current crisis as well as the evolution in banking practices over the past decades. This paper is a concept piece which helps us think through these issues.

Read the paper made for FEPS by Sony Kapoor, Executive Director of Re-Define