The primary argument against financial regulation is that it reduces lending. That is a misunderstanding of the purpose of financial regulation. The purpose of financial regulation is to maintain a stable supply of consumer and business loans, especially when we need it most, during economic downturns.
My father was a small business owner and used to say that when you needed loans the most, you couldn’t get them and when you didn’t need them, banks would send you crystal bowls for the Holidays and heap lending offers on you. That is why we need some financial regulation – to increase the availability of loans when they are needed most
When do we need loans the most? During recessions, not when the economy is doing fine, companies are profitable, and when banks are ready, willing and able to lend. It’s like antibiotics; you don’t want to take them when you don’t need them because then you won’t have any left when you actually need them the most. Yet that is what we do in our financial system. We heap on more loans when the economy is doing well, overheating the economy and reducing the capacity of banks to lend during economic downturns.
What does make sense is preserving lending capacity for a rainy day, otherwise known as the next recession. If we did this, banks would have more lending capacity when we need it most, during recessions. And if regulators also reduced reserve requirements during recessions, banks would have even more lending capacity when we most need it.
So while you can have too much financial regulation, we first need to understand that the purpose of financial regulation is to preserve lending capacity when we need it most, during recessions.
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