Solution to The Financial Crisis

Historically, free banking has been used both with success and failures all around the world. Portions of the United States have had free banking systems in place during times in the 19th century. During a period from 1837-1862 only state-chartered banks existed and the degree’s of freedom for the banks ranged from state to state as was their failure rates (”Free Banking”). During the time period 1935-1964 Canada and Hong Kong both had free banking systems in place. The banking system in Canada during this time was somewhat regulated, but did not require deposit insurance. The banking system in Hong Kong during this time period was virtually unregulated and the government even relied on the private banks to issue currency notes. Under the free banking system in Canada there were no bank failures. In Hong Kong there were only three bank failures, none of which resulted in any losses to depositors. However, the three bank failures in Hong Kong only occurred during the grace period of transition after a move away from free banking had been announced. The U.S. banking system during that time was relatively unstable with multiple bank failures occurring almost every year (Cato). Between 1830 and 1902 Sweden was under a free banking system with much success including breaking the boom and bust economic cycle. During that 72 year time period Sweden had only one bank failure that was a result of fraud on the part of the bank and not excessive lending (”Free Banking”). Free banking, or a system very similar to free banking has also existed in Scotland, Switzerland, The former nation of Rhodesia, and Australia. Comparing the results in the countries under free banking systems during the same period would lead one to conclude that free banking systems are not more prone to bank failures than regulated ones.

Lack of transparency poses problems for the global financial system to this day. Under centralized banking systems like that of the United States banks are required to keep minimum reserve ratios, but also have a lender of last resort in times of financial crisis. However, these benefits come with the problem that banks do not have to compete as vigorously or be as transparent with their financial situations. Deposit insurance is a leading cause in the lack of transparency. “While deposit insurance reduces or eliminated the systemic risk due to contagious bank runs, it also induces a moral hazard problem by encouraging banks to take excess risk.” (Cato).

The free banking system should be given more consideration by policy makers. A question that is being largely ignored is the cost on society of all the financial regulation and monopolization on our nation. “Even if we assume that regulations can succeed in lowering, or eliminating bank failures, the total cost of banking regulations can be much higher than the cost of bank failures.” (Cato). The conclusion can be drawn that government regulation are not necessarily more effective or efficient than a self regulated free banking system. A free banking system would also solve the problems involved with having such large interest rates that are meant to accommodate such large area’s such as the United States, or the European Union. The interest rates in the European Union pose huge problems for the member states as their economies are much more varied in growth rates between nations than are growth rates between states in the United States. The centralized banks do have a few benefits, including the depository insurance which in theory should reduce systemic risk for our financial system.

—Bryce M.