Banking deregulation removes government oversight and restrictions on banks, allowing for increased competition and potential financial growth. Self-regulation is expected to prevent reckless practices, but can also lead to destabilization. Some governments strike a balance between deregulation and oversight to promote free market values.
Banking deregulation is a process in which government oversight of the banking industry is withdrawn, as are many regulations that restrict the activities of banks. When deregulation occurs, it does not mean that there are no restrictions; laws against fraud and other activities are maintained, but the government has a much less direct role in how banks are operated. Deregulation can also occur in other sectors, such as the utility sector or the aviation sector.
This practice is most commonly seen in capitalist countries. The argument for banking deregulation is that it will increase competition, which will ultimately allow for more financial growth, benefiting consumers and the banking industry. Without bank deregulation, some advocates argue, it can be difficult for an economy to grow, because banks can feel too constrained by government mandates. Deregulation should also encourage innovation and creativity in the banking sector, as these activities are often frowned upon by government agencies, who tend to be reluctant to adopt new practices and ideas.
Once banks are deregulated, the idea is that market forces act as a form of self-regulation. In other words, banks will not engage in activities that are in their best interests, and banks may, to some extent, police each other to create accepted standard operating procedure. Self-regulation should ensure that the banking sector does not get out of hand without placing undue hardship on banks.
As some nations have learned the hard way, self-regulation is not always effective. Banking deregulation can lead to the proliferation of extremely reckless business practices, which can actually be encouraged and cultivated in a deregulated banking sector because there are no checks and balances. As large banks adopt new practices and activities, smaller banks can follow suit, causing drastic changes in the way banks do business. While some of these changes can be beneficial, bank deregulation can also turn the economy into a house of cards that can be destabilized all too easily.
Some nations have tried to strike a balance between deregulation and intense government scrutiny. These governments recognize that deregulation can be beneficial and that government oversight tends to be undermined by slow change and slow adoption of ideas. However, they too have seen the consequences of full deregulation and would like to avoid them. In these cases, banking sector regulations allow for some government oversight but still promote free market values.
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