Title: The banking crisis: causes, consequences and remedies
Authors: De Grauwe, Paul
Issue Date: Nov-2008
Publisher: Centre for European Policy Studies (CEPS)
Series Title: CEPS Policy Brief N° 178 pages:1-12
Abstract: The paradigm that financial markets are efficient has provided the intellectual backbone for the deregulation of the banking sector since the 1980s, allowing universal banks to be fully involved in financial markets, and investment banks to become involved in traditional banking. There is now overwhelming evidence that financial markets are not efficient. Bubbles and crashes are an endemic feature of financial markets in capitalist countries. Thus, as a result of deregulation, the balance sheets of universal banks became fully exposed to these bubbles and crashes, undermining the stability of the banking system. The Basel approach to stabilise the banking system has as an implicit assumption that financial markets are efficient, allowing us to model the risks universal banks take and to compute the required capital ratios that will minimise this risk. I argue that this approach is unworkable because the risks that matter for universal banks are tail risks, associated with bubbles and crashes. These cannot be quantified. As a result, there is only one way out, and that is to return to narrow banking, a model that emerged after the previous large-scale banking crisis of the 1930s but that was discarded during the 1980s and 1990s under the influence of the efficient market paradigm.
Publication status: published
KU Leuven publication type: ER
Appears in Collections:Research Center of International Economics, Leuven

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