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Squaring the circle of financial intermediation

Tuesday 13 July 2010 - by Mojmír Hampl

Czech National Bank vice-governor Mojmír Hampl, who is also a member of the European Union’s economic and financial committee, is concerned by the perfectionists who are out in force on the regulation front

If the ancient geometers were watching the current debate about appropriate future regulation of the financial sector, they would probably see a strong analogy with the age-old, logically impossible task of squaring the circle.

Many participants in the financial regulation debate now have the ambition to create a future financial sector that will be perfectly efficient, perfectly safe for savers or investors and will never require life support from taxpayers as a result of moral hazard behavior.

In this ideal world, financial institutions are innovators, providing their clients with cheap services and smooth, growth-enhancing maturity transformation, while nobody ever has to worry about their investments and deposits and taxpayers never have to pick up the bill.

There is no doubt that we would all love to have a financial sector that fully meets all these criteria.

Alas, in reality we can hardly achieve all these objectives at the same time. We can have an efficient financial sector which fuels economic growth and in which savers and investors need not worry much about their funds – but then the sector will inevitably exhibit moral hazard, resulting sometimes in a necessity for the public to pick up the tab.



Or the financial sector can be efficient and never require any public action – but then savers and other investors in this not-perfectly-safe sector will simply lose a lot of money now and again. Finally, we can tame the sector into a creature that is safer for both savers and taxpayers. But this creature will be little more than a cash-vault, far from competitive, efficient, and growth-enhancing.

Of course, in reality we must always find an equilibrium between all of these principals.

But does the current debate give a promise of finding a better equilibrium for the future? Not necessarily, I am afraid.

Politicians fail to grasp that financial intermediation has been and always will be inherently fraught with problems of asymmetric information and risk. In front of their audiences they pretend that it is possible to eliminate the problem of risk once and for all.


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