The drive to regulate banks after the crisis of 2008 follows the usual pattern of financial crises: Immediately after the crisis, stringent regulations are introduced to ensure that it cannot repeat itself; over time, the memory fades and complacency grows; regulations are gradually stripped away until a new bust occurs; and the process starts over. This cycle was last seen after the 1929 Wall Street Crash, after which the Glass-Steagall Act of 1933 tried to ensure that U.S. banks could not take such risks again. But a misplaced confidence in risky banking processes grew, and in the 1970s and 1980s there was an extended period of deregulation on both sides of the Atlantic.
The crisis of 2009 was to a large extent a result of banks' ability to take gigantic risks alongside an interlending culture that resulted in a connected network of loans (meaning that if one bank was allowed to fail, the whole system might follow). Ever since Harry Thornton's An Enquiry into the Nature and Effects of the Paper Credit of Great Britain in 1802, central bankers have known that allowing insolvent banks to fail is key to ensuring that others do not take extreme risks, but Thornton also wrote that a lender of last resort's first responsibility was to the system as a whole. This is the contradiction faced by central bankers in 2008 and 2009, who ultimately chose to adhere to the latter principle with "too big to fail."
Now G-20 members are struggling to regulate banks amid a complicated economic climate. Regulations thus far have been focused on reducing the risks a bank can take, while Financial Stability Board Chairman Mark Carney's latest measures are designed more to limit the interconnectedness of the market, creating a situation where insolvent global banks could be allowed to fail safely. Carney's new measures, called total loss-absorbing capacity (TLAC), mandate that a diverse range of investors and institutions hold the bonds and shares of each bank and that they be able to absorb the shock of its collapse.
The proposed measures have received backlash, especially from European banks. Nevertheless, at least in the West, too big to fail will end, at least in the medium term. Ultimately, complacency and greed will erode the new regulations and a banking crisis will result, though that will fall within the purview of a regulator far in the future.
