Is it possible to over-regulate the banking system?


Since the days first banks were opened, debates over how the banking system should be regulated have persisted. After the mortgage crisis of 2008, the debates reached a peaking point because the crisis was mostly caused by the actions of the banks. In my opinion, it is definitely possible to over regulate the banks.

Why banks should not be regulated

A major reason why banks should not be regulated too strictly is that it would violate free market principles. Banks are an essential component of a market economy, and by controlling their work, there is a danger that the government will gain too much control of the market. In other words, because governments could set the loan rates — that have a huge influence on the cost of production — governments would be able to regulate the prices of most domestically produced goods. Of course the Central Bank already has a large influence on banks because it controls the loan rates, which are given to the banks. Thus, the Central Bank indirectly influences the deposit and credit rates. However, central banks do not use this instrument frequently, in fact mostly only during times of soaring inflation.

Moreover, if the government has too much control over the banking system, people lose the desire to invest in the country. The high concentration of power in the hands of the government, and thus the likely lack of a free market, disincentivize potential investors. In other words, people are scared that governments can make decisions that are beneficial only to the government itself. Of course the more power the government has, the easier this is for the government to overrule the banking system. When the government controls the economic life of a country, it starts to become authoritarian. This was explained by professors James Robinson and Daron Acemoglu in their book “Why Nations Fail?”. Robinson and Acemoglu state that countries fail if the government has too much control over the economy. People are unlikely to invest money if they are unsure of whether the money will be returned to them. The book also explains that having strict governmental control of the economy can have a positive effect in the near future but is destructive in the long-term.


However, not regulating the banking system at all is a false narrative in my opinion. Banks are keen to maximize their revenues and, thus, can make decisions that are not beneficial to a country’s economy. For example, banks may decide to give out loans to people who they know cannot afford them. This means that the purchasing ability of the entire population decreases. To minimize their risks, banks can transform the credits and mortgages into obligations and sell them. This way, they do not carry the risks themselves but even increase their revenues instead. Such actions caused the mortgage crisis of 2008, which had absolutely horrible consequences to the world economy. To conclude, I think that the banking system should not be over-regulated.

By Fedor

Hello! My name is Fedor and I am a high school student from Moscow, Russia. My interest in economics is combined with deep knowledge in world history, which allows me to see the world form a different perspective. I love gaining new knowledge about politics, economics and finance and I think it is essential to comprehend the current situation in the world!