May, 2016

Banking Regulation and Knowledge Problems

  • Thomas L. Hogan

    Fellow in Public Finance, Baker Institute Center for Public Finance, Rice University
  • G. P. Manish

    BB&T Professor of Economic Freedom, Manual H. Johnson Center of Political Economy, Troy University
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Find the article at Emerald Insight.

The Federal Reserve regulates U.S. commercial banks using a system of risk-based capital (RBC) regulations based on the Basel Accords. Unfortunately, the Fed’s mis-rating of several assets such as mortgage-backed securities encouraged the build-up of these assets in the banking system and was a major contributing factor to the 2008 financial crisis. The Basel system of RBC regulation is a prime example of a Hayekian knowledge problem. The contextual, tacit, and subjective knowledge required to properly assess asset risk cannot be aggregated and utilized by regulators. An effective system of banking regulation must acknowledge man’s limited knowledge and place greater value on individual decisions than on top-down planning.