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What is Banking Deregulation?

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  • Written By: Mary McMahon
  • Edited By: O. Wallace
  • Last Modified Date: 08 November 2016
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Banking deregulation is a process in which government oversight over the banking industry is withdrawn, as are many regulations which restrict the activities of banks. When deregulation occurs, it does not mean that no restrictions in in place; laws against fraud and other activities are retained, but the government has a much less direct role in how banks are operated. Deregulation can occur in other industries as well, such as the utility industry or the airline industry.

This practice is most commonly seen in capitalist countries. The argument for banking deregulation is that it will increase competition, which will ultimately allow for more financial growth, while benefiting both consumers and the banking industry. Without banking deregulation, some advocates argue, it may be difficult for an economy to grow, because banks may feel too restricted by government mandates. Deregulation is also supposed to encourage innovation and creativity in the banking industry, as such activities are often frowned upon by government agencies which tend to be reluctant to adopt new practices and ideas.

Once banks are deregulated, the idea is that market forces will act as a form of self regulation. In other words, banks are not going to engage in activities which run against their best interests, and banks may, to some extent, police each other to create an accepted standard operating procedure. Self-regulation is supposed to ensure that the banking industry does not get out of control, without placing undue hardship on banks.

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As some nations have learned the hard way, self-regulation is not always effective. Banking deregulation can lead to the proliferation of extremely unwise business practices, which may actually be encouraged and cultivated in a deregulated banking industry, because there are no checks and balances. As major banks adopt new practices and activities, smaller banks may follow suit, causing dramatic shifts in the way that banks do business. While some of these shifts may be beneficial, banking deregulation can also turn the economy into a house of cards which can be destabilized very easily.

Some nations have attempted to strike a balance between deregulation and intense government scrutiny. These governments recognize that deregulation can be beneficial, and that government oversight tends to be hindered by slow-moving changes and sluggish adoption of ideas. However, they have also seen the consequences of total deregulation, and they would like to avoid these. In these cases, regulations on the banking industry allow for some government oversight, but still promote free market values.

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Discuss this Article

anon350744
Post 4

This is an excellent article. It is precise, well presented, excellently researched and easy to understand and follow without any unnecessary ambiguity and financial jargon.

tigers88
Post 3

I have heard a lot about banks and the economy and regulation. These are some of the biggest issues of the day but, I have to be honest, I do not understand these concepts very well. I really wish that that someone could lay out the relationship between these three things in simple laymans terms. Is anyone up to the task or can they point me to a place where I can find good information?

summing
Post 2

@jonrss - I have to disagree with you. While I know that the banks did not behave perfectly in the boom cycle that happened through most of the 2000s, I don't think they were the ultimate cause of the burst.

In fact, I think it was government policies which went to crazy lengths to incentivize home buying that created the whole root of the problem. It was not lack of regulation but regulation itself which caused all these problems. I am not naive, I know that the free market has its problems, but we have to be honest about the role the fed plays when the economy goes downhill.

jonrss
Post 1

I am strongly against any kind of banking deregulation. The biggest argument for deregulation is that it frees up banks and other industries to innovate their practices and hopefully offer better products for consumers. This is the theory but very rarely the result.

As a matter of fact, I think our current economic situation is due in large part to a lack of regulation and oversight of the banking and more broadly the entire financial industry. They were allowed to carry out shady practices on a massive scale and now our economy has lost trillions of dollars. Lets not loose focus of what started this mess. It was not social security, it was not even Fannie and Freddie, it was major banks making huge bets and losing big, then rushing to the taxpayer for a bailout. Strong new regulations are the only way we can avoid a future bust.

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