What is Banking Deregulation?

Banking deregulation is a process in which government oversight over the banking industry is withdrawn, as are many regulations which restrict the activities of banks. When deregulation occurs, it does not mean that no restrictions in in place; laws against fraud and other activities are retained, but the government has a much less direct role in how banks are operated. Deregulation can occur in other industries as well, such as the utility industry or the airline industry.

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, while benefiting both consumers and the banking industry. Without banking deregulation, some advocates argue, it may be difficult for an economy to grow, because banks may feel too restricted by government mandates. Deregulation is also supposed to encourage innovation and creativity in the banking industry, as such activities are often frowned upon by government agencies which tend to be reluctant to adopt new practices and ideas.

Once banks are deregulated, the idea is that market forces will act as a form of self regulation. In other words, banks are not going to engage in activities which run against their best interests, and banks may, to some extent, police each other to create an accepted standard operating procedure. Self-regulation is supposed to ensure that the banking industry does not get out of control, 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 unwise business practices, which may actually be encouraged and cultivated in a deregulated banking industry, because there are no checks and balances. As major banks adopt new practices and activities, smaller banks may follow suit, causing dramatic shifts in the way that banks do business. While some of these shifts may be beneficial, banking deregulation can also turn the economy into a house of cards which can be destabilized very easily.

Some nations have attempted 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 hindered by slow-moving changes and sluggish adoption of ideas. However, they have also seen the consequences of total deregulation, and they would like to avoid these. In these cases, regulations on the banking industry allow for some government oversight, but still promote free market values.