DESARROLLO DEL TALLER DE LA UNIDAD

The role of banks has always been a very important one in any world economy. Banks world-wide, have over the years played a vital role in any ‘payment mechanism system’. From a previously traditional role where they accepted deposits from depositors who entrusted them with their money, banks have also always provided a main source of finance for many borrowers229_.

Over the years, banks (particularly large banks) have in addition to retaining their traditional function as deposit-taking financial institutions, been engaging in other banking activities which at best could be described as ‘profit-making’ financial activities. While such activities230 _{in themselves have never been}

229 _{Howard Davies, ‘Why Regulate Banks’, A Paper presented at the Henry Thornton Lecture} on 4 November 1998, p30.

230

Such as Fractional-Reserve Banking, a banking practise which permits banks to lend a significant amount of their deposits notwithstanding the fact that in doing so, they will only be retaining the barest minimum of deposits as reserve.

contrary to banking regulations, and in fact have been largely encouraged by the banking industry, it has become a widely known and acceptable reason that these ‘other banking activities’ tend to amplify or exacerbate the risks that already exist231 _{or emanate from their more traditional role.}

Inspite of systemic risk being an unacceptable risk element in the activities of banks, and indeed a growing one in the relationships that banks have with one another, both nationally and globally, this inherent form of risk has assumed great significance particularly where banks have seemingly tended to move from perhaps the more common form of profit-making activities through fractional-reserve banking to the sophistry of dealings in largely innovative banking products specially designed to yield even more profits for the banks.

It must be pointed out, that although systemic risk, is an ever-present risk element in any banking system, the inability of banks to control it through adequate prudential bank regulation, heightens the likelihood of local and cross-border contagion within the banking systems of any given jurisdiction, which ultimately becomes an unwelcome recipe for bank failure.

Rosa Lastra, underscored the important role that banks play in a given jurisdiction in an article232 _{which is referred to by the author in an LLM} dissertation where the author states that banks are special because:

‘when they fail, there is the added “real possibility”233 _{of a spread of}

systemic risk through contagion, which may result in healthy banks suddenly facing liquidity crisis and ultimately potential collapse due to their intricate bank-on-bank relationships and inter-dependency in the inter-bank market’234_.

231

Namely credit risk, liquidity risk, yield risk, market risk, and operational risk. See D. Llewelyn, ‘The Economic Rationale for Financial Regulation’ FSA Occasional Paper Series 1, April 1999 for a more detailed discussion.

232 _{Rosa Lastra, ‘Northern Rock, UK Bank Insolvency and Cross-border Insolvency’ (2008)} Journal of Banking Regulation Volume 9 No.3, 165.

233 ibid.

234 _{J De-graft, ‘Deposit Insurance Protection: Developing a Legal Framework for Ghana’ LLM} Dissertation University of Leeds 2010, p34.

Thus, while the ‘systemic risk’ and ‘subsequent potential collapse’235 _argument is a valid reason for attributing importance to banks, a further argument that could be raised in support of the ‘bank importance’ phraseology, is that when banks fail, depositors are left exposed to the workings of regulations236 _or official policies237 _{that may already be in place to either safe-guard all their} deposits, or at worst some of it.

In such a scenario, the protection of a bank depositor’s funds will be dependent on the existence of deposit insurance mechanisms amongst others238 _{within a given jurisdiction, and where that exists, the amount the} depositor is able to reclaim will depend on the terms of the deposit insurance. Banks are also important because they deal with each other in the inter-bank market and the inability of one bank to settle with another may have a direct impact upon the bank which has not been paid239_{. This in turn may make the} bank unable to meet its obligations towards a third bank, and so on.

Another reason why banks are considered important is due to the fact that they deal in maturity transformation240_{, which means that they transform} illiquid assets, such as loans, into liquid liabilities such as deposits. Because of the nature of fractional-reserve banking, banks will never have sufficient liquid assets to meet all liabilities241_.

This will be problematic, if for some reason, an unexpectedly large number of depositors demand their funds at the same time242_{. Because it is very difficult} for customers to distinguish between healthy and unhealthy banks, this may mean that perfectly well-managed banks are also put at risk of a bank run. Thus, while the importance of banks is undisputed, it is this same level of importance, which provides a host of reasons for banks to be regulated.

235 ibid. 236

Such as national insolvency banking regulations. 237

Lastra (n232). 238

Such as Lender of Last Resort role of any Central Bank. 239

Davies (n229) 29. 240

H M Schooner and M W Taylor, Global Bank Regulation: Principles and Policies 1st Edition Academic Press 2010 pp20-21.

241 ibid. 242

This may be due to a complete erosion of the confidence that depositors and investors hitherto had in banks.