Getting Banks off the Roller Coaster

Bank executives like to say that their most important job is managing risk. This does not mean they’re good at it. Banks the world over have often failed to monitor hazards properly, blowing up spectacularly every few decades. Regulations drafted in the wake of the global financial crisis were supposed to curb dangerous behavior. Yet the complex new rules repeat a mistake that led to the banks’ troubles in the first place: They assume bank executives and regulators can figure out what is risky.

Now a handful of regulators on both sides of the Atlantic are pushing for a less complicated approach. They argue that the only way to make sure financial institutions don’t fail when their bets go bad is by relying on dead-obvious restrictions on leverage. For every dollar of capital a bank has, it can lend a fixed amount, say $10, regardless of how risky or non-risky it claims that loan to be. That way the bank can take any risk it wants as long as there’s enough shareholder equity to cover the potential losses—so taxpayers aren’t stuck with the tab if it collapses.