The Functional Approach To

Conventional wisdom contends that in order to assure financial stability, commercial banks require an elaborate federal regulatory and insurance structure and direct access to the central bank. Nonbank financial institutions apparently pose no threat and, therefore, merit less regulatory attention, no insurance, and no direct access to the central bank. Until relatively recently, the conventional wisdom was rarely challenged, and to this day it is viewed as bad form in some circles to ask why banks receive special attention. The conventional approach to deposit insurance and bank regulation takes as given the deposit insurance and regulatory structure put into place in the early 1930s. Thus, it is assumed that commercial banks, operating with low net worth, will continue to issue federally insured or guaranteed liabilities (deposits) to support a host of risky and difficultto-evaluate activities. In effect, it is also assumed that deposit insurance will continue to provide a valuable subsidy to banks, one that requires extensive regulation and supervision to limit bank risk (Merton 1977). Repairs in the institutional structure may be needed from time to time, such as provision for early supervisory intervention in an effort to limit the Federal Deposit Insurance Corporation’s credit exposure, but the basic structure is left unchanged. And proposals will continue to be made for improvements, subject to the constraint that basic institutional arrangements remain unchanged. For example, most of the papers at this symposium are concerned with improvements: the use of bank regulation to control cycles in risky lending, and methods to achieve risk-sharing between the federal authority and private agents. These