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Can It Be Prevented This Time?: The Role of Profits in Banking Regulation

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  • Giuseppe Mastromatteo
  • Lorenzo Esposito

Abstract

Since the nineties, crises have punctuated financial markets, shattering the conventional wisdom about how these markets work and how to regulate them, and forcing a deep rethinking of the supervisory framework that, however, did not change much of the banks' behavior and incentives. In particular, banking regulation did not face the nexus profitability-riskiness. Based on Minsky's financial instability hypothesis, we discuss the literature on banks' profitability and its relation to the originate-to-distribute model. We also propose a different strategy for banking regulation, based on a profitability cap that prevents financial innovation from overwhelming supervision. Finally, we discuss the data for the US case, confirming the importance of profitability as a signal of incoming troubles and the possibility of using the profitability cap to greatly simplify banking regulation.

Suggested Citation

  • Giuseppe Mastromatteo & Lorenzo Esposito, 2023. "Can It Be Prevented This Time?: The Role of Profits in Banking Regulation," Economics Working Paper Archive wp_1021, Levy Economics Institute.
    • Handle: RePEc:lev:wrkpap:wp_1021
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    Keywords

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    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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