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Chained But Untamed

THE NEAR-COLLAPSE of the world’s banking system two-and-a-half years ago has prompted a fundamental reassessment of the industry. Perhaps the biggest casualty of the crisis has been the idea that financial markets are inherently self-correcting and best left to their own devices. After decades of deregulation in most rich countries, finance is entering a new age of reregulation. This special report will focus on these regulatory changes, which will be the main determinant of the banks’ profitability over the next few years.

Start with the additional capital that banks around the world will have to hold. Bigger capital cushions will make the system somewhat safer, but they may also reduce banks’ profitability by as much as a third. In addition, they may push up borrowing costs and slow economic growth. Worse, higher capital requirements for banks may drive risk into the darker corners of financial markets where it may cause even greater harm.

Supervisors and regulators almost everywhere are still trying to find ways to deal with banks that have become too big or too interconnected to be allowed to fail. If anything, the crisis has exacerbated this problem. Some of those banks have become even bigger or more interconnected. And governments made good on the implicit guarantees offered to banks, encouraging them to take even bigger risks.

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