Financial innovation and deposit insurance: the 100 percent cross-guarantee concept

Dramatic changes in recent decades in the economics of the finan-cial services industry, due largely to the computer revolution, have destroyed the efficacy of traditional financial services regulation. Despite these developments, the federal government has merely tin-keredwith the current regulatory system. Suchtinkering is counterpro-ductive because the current rigid, central-planning style of financial services regulation is inherently flawed. Instead, we must create a market-driven regulatory model that gives individual banksandthrifts the flexibility to pursue unique business strategies. The 100 percent cross-guarantee concept is a reform proposal that would meetthis test. Embodied in legislationintroduced in September 1992 by Rep. Tom Petri (R.-Wis.), its implementationwill quickly lead to better-priced and therefore wiser bank lending while eliminating the risk federal deposit insurance now poses to taxpayers. Cross-guarantees also will end “regulatory arbitrage, ” that is, the ffight of lower-risk assets from banks andthrifts to less-taxed andless-regulated channels of financial intermediation. Americawould have a safer and more efficient financial system as a result. The Traditional Regulatory Model The traditional regulatory modelfor depositoryinstitutionsemerged in the United States during the 19th century. Entry into banldng was restricted and banks and thrifts were highly regulated as to their capital, liquidity, and lending. These regulations were enforced by bank examiners and supervisors under the premise that individua