A Path Toward Less Restrictive Regulation

My colleague Travis Fisher recently co-wrote a piece in the Wall Street Journal on utility reform in New Hampshire. The New Hampshire story should be quite familiar to anyone who studies financial markets.

The state’s highly regulated electricity industry is struggling to provide consumers with the power they need. To solve the problem, the legislature came up with a simple solution: Anyone who produces electricity in New Hampshire won’t be subject to public-utility regulation provided they don’t connect to the existing grid.

The financial sector can learn from this example. It is also overregulated, and something akin to a light version of this New Hampshire solution has already been a success for a slice of the banking sector. (More about that below.) An expanded version is exactly what’s needed in financial markets.

Yes, that’s right—financial markets do not need to be regulated like public utilities. The fact that financial markets, especially banks, are increasingly regulated as if they were utilities is nothing to be happy about.

The existing regulatory framework makes it harder for people to provide financial services, and the supposed benefit from this approach—financial stability—has remained elusive for centuries.

Bank Regulation Has Yet to Provide Stability

Supposedly, financial markets need prescriptive rules to guarantee safety, and if we can just get the rules right, everything will be fine.

The fact that this approach has never worked should not surprise anyone. If we are going to allow people to take financial risks, something which a free society must allow, then there is simply no way to compile a set of rules that guarantees everything will be fine.

Thinking it will one day work is akin to thinking socialism will finally work once we try the “right” version. It’s wishful thinking.

Regulators make mistakes because they’re people too, and nobody has perfect foresight. The current approach trusts regulators’ judgment instead of the judgment of everyone else, and it results in everyone else having less control over their own money. It’s left us with a massive set of rules that protect incumbent firms more than anyone else. It slows down innovation and shrinks economic opportunities for everyone, including the people who would otherwise pay less for those services and those who would otherwise provide new services.

But it does not have to be this way.

Free Enterprise Works in Financial Markets Too

Financial regulation can be based on rules that mainly protect people from fraudulent behavior. Financial regulation does not have to be based on restricting what people can do with their money because regulators deem certain choices as “too risky.” Perhaps most importantly, financial losses don’t have to be backed up by the government, a process that results in people taking more risks than they otherwise would.

If Congress wants a resilient financial sector, then they’ll let people exercise their own judgment, cautiously, knowing that they will make mistakes. That won’t lead to perfect outcomes, but no approach will, especially one that tries to maintain stability.

Even the basic idea behind federal deposit insurance has already failed. Supposedly, it provides the confidence necessary to conduct banking, but even people covered by FDIC insurance “run” to get their money out of failing banks. Yet Congress keeps flirting with expanding FDIC coverage practically every time there’s a banking problem.

The good news is the banking sector already has a blueprint for moving away from the failed regulatory approach. It’s the light version of the New Hampshire electricity market solution: The community bank leverage ratio that was enacted in 2018.

Expand the Community Bank Leverage Ratio

The CBLR was designed to give “small” banks a way to simplify their capital requirements. The mechanics are as follows: Any bank with assets less than $10 billion can get an exemption from the general bank capital rules if it chooses to maintain a higher capital ratio. As of 2024, about 40 percent of the nation’s “small” banks took the deal.

So, let’s expand it. Just like the New Hampshire electric utility exemption, the expansion would give people a choice.

In this optional framework, anyone who maintains a higher capital ratio can open a bank wherever they like and be exempt from the existing regulations that dictate how banks can operate. They would still be prohibited from committing fraud—that’s not a banking regulation.

To make this work, the new banks would be explicitly prohibited from purchasing FDIC insurance or participating in any Federal Reserve or Federal Home Loan Bank lending programs. Existing banks could start affiliates to take advantage of the new opportunities.

If the existing federal system really is so great, nobody will take the new option and there’s nothing to worry about.

Let Bankers Run Their Banks

Maybe the take-up rate won’t be so high, but nothing about the existing regulatory system resembles anything a rational person would construct. If we can’t dismantle it piece by piece, then let’s give people an option to live under a different system.

Either way, federal officials need to come to grips with the fact that a free enterprise system is best, even in financial markets. The regulatory framework should let bankers be bankers, not force them to operate the way federal regulators want them to operate.

Let’s hope that the New Hampshire electricity revolution sparks something in financial markets.