Why free banking? part 1

Banking industry has made great contribution to decades of economic development. Nowadays, banks’ performance can strongly influence economy stability.

The question of “Should banks be regulated or just let them develop freely?” has been discussed widely by people. In this blog, I would try to find out the answer to this problem. In this part, I would concentrate on the reasons of why some people support free banking system. In White's book in 1995, free banking is generally described as 1, no central bank. 2, unlimited issue currency and deposite.

Another literature written by Chu in 1996, which collected many ideas supporting both aspects. Later on with a comparison among three countries, a result which explained the free banking is not the reason of banking instability was drawn.

Generally, people argue free banking could result in bank instability, because with externalities, natural monopolies and asymmetric information, more fraud would appear, banknotes would be over issued and banks would have no restrict on expanding. On the other hand, if banks are regulated, there are plenty of benefits such as depositors can be protected, payments are guaranteed, etc. Therefore, a stable banking system can be formed.

However, people like Hayek believes that in free banking system, banks would compete in supply of money, also by considering their brand, over issued money would less likely happen. There are some other ideas shows that banks’ diversification can be limited by regulation, more moral hazard problems and higher taxes also reduce banks’ profit.

In the test of Chu’s article, by considering the number of banks’ failure, from 1935 to 1964, both Hongkong banks that are unregulated and Canadian banks which are regulated have no bank failures appear, but in the US which only regulated its deposit insurance has bank failures in every year. Therefore, it shows that the banking regulation is not necessary.