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Corresponding Author:
Stefano Mieli, Former BANCA D'ITALIA economist

Is Prudential Regulation Prudent?

May 13, 2025
JEL classification: G18; G21; H12; H81
Keywords: Financial Crises; Bank Regulation; Bank Run; Basel Accord on Capital; Bail-in; Prudential Regulation; Value at Risk; Too Big to Fail

Abstract

The financial system is periodically hit by crises that erode confidence in the effectiveness of countries’ regulatory and supervisory regimes.

The historical evolution of banking controls shows there has been a swinging back and forth to a stricter regulatory framework. The Basel Accord on Capital aimed at modernizing the methods of controlling banks while allowing them to behave freely as firms.

After the 2007/2009 crisis, the reliance on market-oriented instruments was strongly reduced. In addition, to minimize fiscal costs, the emphasis switched from bail-out to bail-in. This note argues that bail-in has a potentially dangerous effect on stability. In particular, uninsured depositors have incentives to run. Doubts are also pointed out with regard to the effects of market discipline as well.

In conclusion, inter alia suggestions, reassuring depositors by admitting that governments can act as a last guarantor is recommended. To counteract the bankers’ moral hazard, supervisors should receive full powers to act to stop risky behavior by banks.

Financial stability is threatened by Too Big To Fail (TBTF) banks, and the size of large banks should be reduced. Also, some limitations of risky activity for banks should be reintroduced worldwide.

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Is Prudential Regulation Prudent?

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Institute for International Economics of the Genoa Chamber of Commerce

Institute for International Economics
of the Genoa Chamber of Commerce