An Alternative Approach to Financial Regulation

From the previous narrative, one main point emerges: the existing balance in the public­private partnership must be changed at the international and the national level. This implies in the first instance a radical rethinking of globalization.

Keynes, a liberal, criticized the extreme configurations of protectionism and global­ization for international trade (proposed to keep finance firmly national) and reserved unfettered globalization to the circulation of ideas and tourism. His argument rests on the need to acquire degrees of freedom for directing policies toward national welfare (Keynes, 1933).¹⁸ Also the Clearing Union plan that he prepared ten years later for the Bretton Woods conference does not attribute any critical role to private international finance. Primarily interested in keeping unemployment low by public and private invest­ments, Keynes was not friendly with financial rents. He would have criticized today’s justification of international finance as permitting higher rents for rich countries’ wealth owners coming from financing investments in less-developed countries. AsJan Kregel argues, this is just bad dynamic theory and unwillingness to learn a lesson from the expe­rience of the last four decades. Setting up regional Keynes-type clearing unions could be a first step for designing new public governance that could progressively substitute private international flows (Kregel, 2015).

Making finance national would also dispense with the multitude of international reg­ulatory standards that were set up to discipline international financial firms. Following Hyman Minsky, I have shown elsewhere (Tonveronachi, 2016) that the pursuit of the level international regulatory playing field does not take into account national specifici­ties and physiological needs. Given different national conditions, homogeneous regula­tory requirements lead either to fostering fragile and ever increasing financialization, or to insufficient credit growth.

This comes from the fact that the long-term potential growth rate of bank assets, based on internal resources, depends on the share of retained profits, hence on the retention ratio, the return on assets and leverage (assets over own capital). While microprudential regulation tends to constrain the maximum value of leverage, the value of the other two variables comes from a complex set of private decisions and structural conditions. The resulting growth potential may then exceed or fall short of the potential growth of nom­inal national gross domestic product (GDP), a worrisome result if we think of finance as serving the economy. The impetuous and fragile growth of financialization and of finan­cial firms’ dimension over the last decades shows how and how far the laissez-faire system has grown in the absence of a public systemic design. The so-called macroprudential regulation spurred by the 2008 crisis falls short of adopting a systemic approach.

Following Minsky, financial regulation should pursue the objective of roughly equat­ing the growth of bank assets and the growth potential of nominal GDP in the medium term. Minsky suggests that regulation should establish a common maximum leverage for all banks and then operate on the retention ratio to reach the desired balance. This Copernican revolution would disrupt the Ptolemaic G20 approach. In coordination with fiscal and monetary policy, financial regulation should look at national sustainable objec­tives, not at the international and national microprudential level playing field. National ownership of financial regulation would be consistent with Keynes’s suggestion to keep finance national. Once downsized to exist only as national entities, the dimension, power and ownership structure of financial firms could be treated according to national prefer­ences, without the latter spilling over to other countries.

Public authorities should take control of the main features of the entire design of the financial system, not just of the banks as defined in the current regulatory framework. Debt and its function should be the discriminating factors (Tonveronachi, 2016). The physiology of debt of financial firms is what Minsky calls the “acceptance function,” which in the present institutional context means the credit created to serve a dynamic economic system. Debt should not be used just to amplify returns or losses. Funding via debt should be restricted to the acceptance function, that is, to what we can go on call­ing banks. Any financial firms using debt should be treated as a bank, and any nonbank financial contract should only be funded by shares. In this way, shadow banking and fictitious liquidity (Kregel, 2012b) would disappear as well as the necessity of burdening nonbank entities with capital and liquidity requirements. We could thus obtain simplicity and effectiveness instead of ineffective complexity.

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