Jeremy Bulow, Jacob Goldfield, Paul Klemperer, 29 August 2013

Today’s regulatory rules – especially the ineffective capital requirements – have led to costly bank failures. This column proposes a new, robust approach that uses market information but does not depend upon markets being ‘right’. Under the proposed regulatory system (i) bank losses are credibly borne by the private sector (ii) systemically important institutions cannot collapse suddenly; (iii) bank investment is counter-cyclical; and (iv) regulatory actions depend upon market signals. One key innovation is ‘Equity Recourse Notes’ that gradually ‘bail in’ equity as needed. These are superficially similar to, but fundamentally different from, 'CoCos'.

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