Americans have taken a number of lessons away from the post-war experience with banking regulation. First, government deposit insurance protects small savers and helps maintain the stability of the banking system by reducing the danger of runs on banks . Second, interest rate controls do not work. Third, government should not direct what investments banks should make; rather, investments should be determined on the basis of market forces and economic merit.

Fourth, bank lending to insiders or to companies affiliated with insiders should be closely watched and limited. Fifth, when banks do become insolvent, they should be closed as quickly as possible, their depositors paid off, and their loans transferred to other, healthier lenders. Keeping insolvent institutions in operation merely freezes lending and can stifle economic activity.

Finally, while banks generally should be allowed to fail when they become insolvent, Americans believe that the government has a continuing responsibility to supervise them and prevent them from engaging in unnecessarily risky lending that could damage the entire economy. In addition to direct supervision, regulators increasingly emphasize the importance of requiring banks to raise a substantial amount of their own capital. Besides giving banks funds that can be used to absorb losses, capital requirements encourage bank owners to operate responsibly since they will lose these funds in the event their banks fail.

Regulators also stress the importance of requiring banks to disclose their financial status; banks are likely to behave more responsibly if their activities and conditions are publicly known. ---

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This article is adapted from the book "Outline of the U.S. Economy" by Conte and Carr and has been adapted with permission from the U.S. Department of State.