Raghuram Rajan: belief

Transcript context

…But why? What’s the nature of their informational advantage? How do we model it? How do we think about it? I think it’s not so much on the lending side. They have some ability there. But it’s just the fact on the depositors’ side that it doesn’t require a genius to keep testing the bank. If you want your money, you go in and say, “I want it back today.” That is a disciplinary mechanism on the bank which has stood the test of time. Is it still necessary today? Even today, when you see what forces the bank into distress, it’s the run on the banks by the large depositors. That’s an enormous disciplinary device on the banks, keeps them from going off the straight and narrow. We prevented the small depositors from earning through deposit insurance. But even today, what closes a bank down is when the large guys say, “These guys are not good for our money. We’re going to take it out.” And that’s when it closes. I think that basically forces a bank to stay on the straight and narrow to the extent possible. Of course it creates the downside of financial-sector risk, but it is a fairly strong governance mechanism, much better than the equity holders in the bank who have no clue as to what it’s doing. But say if there’s deposit insurance, especially in the US, where resolution occurs quite quickly, why should that discipline be much of a force? If I have a hundred thousand dollars in a bank and they screw up, I still have my money. I don’t really have to wait. Why should the bank have some kind of comparative advantage?…

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