One of the ironies of financial regulation efforts since the 2008 financial crisis is that they may have strengthened the relative position of the largest financial institutions while raising barriers to entry. The Economist touts the rise of innovative peer-to-peer lenders and payment services, yet it calls for less heavy-handed, more differentiated regulation to encourage business model innovation in core financial services:
Banks need to be more heavily regulated than other firms because of their central role in the economy. However, governments could regulate more smartly, raising capital requirements for big and systemically important banks while easing the burden on smaller ones. Regulators should be even more relaxed about many of the new entrants to the market, most of which simply provide quicker and simpler ways of shifting money around. Most of these start-ups avoid the alchemy of banking—the transformation of short-term deposits into long-term loans—so pose little systemic risk.
The idea of lighter-touch regulation will seem to many an anathema after the financial crisis. It would certainly lead to more failures by small banks and start-ups. This would also impose some costs on society and deposit-guarantee schemes. Yet these costs would be outweighed by the enormous benefits to consumers and businesses of a far more competitive financial system.
I am sympathetic to this line of thinking. I also believe, however, that a more innovation-friendly approach to regulation needs to be accompanied by a back-to-the-future approach to meeting the needs of plain-vanilla savers. If the U.S. could somehow recreate ”postal savings accounts” — essentially, all U.S. citizens and permanent residents would be entitled to open savings accounts with the federal government, which would be invested in Treasury debt and which would pay interest at the federal funds rate — we could allow the private sector to engage in far more risk-taking, as postal savings would obviate the need for deposit insurance. For-profit firms could compete to serve as a front-end consumer experience in exchange for some small fee, and of course savers seeking higher returns would be free to enter what would be a far more laissez-faire private financial sector. This approach would actually be less statist in effect than the status quo, which essentially turns all major financial institutions into quasi-public institutions.