Following the 2008 financial crisis, a major process of regulatory reform of the banking industry took place

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Following the 2008 financial crisis, a major process of regulatory reform of the banking industry took place with the aim of increasing the resilience of the financial system. Touted as the most extensive proposal for the overhaul of financial rules since the Great Depression, the 2010 Wall Street Reform and Consumer Protection Act (The Dodd-Frank Act) proposed a sweeping overhaul of the U.S. financial system and the rules that govern it. The Basel III regulation forces banks to improve their ability to absorb shocks arising from financial and economic stress by requiring them to maintain a much larger capital base, increasing transparency and improving liquidity. Every year, the Federal Reserve conducts a round of stress tests purported to ensure that the banking system can weather a financial crisis.

While the regulatory reforms have significantly improved prudential banking supervision and made the system safer, they have already had a major impact on the regulatory burden for banks. Some people doubt if we really want banks to hold enough capital to survive crises that have no US historical precedent. Even if such an extreme economic crisis did occur, would any amount of capital be enough to withstand the panic it could trigger? Some people claim that the Fed's stress tests use adverse scenarios that are extreme to the point of incredulity. For example, the latest stress test assumes an increase of the unemployment rate from 4.1 to 10 percent over seven quarters. That has not happened in the 70 years since today's measure for unemployment was adopted. There is also empirical evidence that higher bank capital requirements cut lending and economic growth. Thus, some people advocate that regulators should ease regulation to free up lenders to provide more credit and boost the economy. So, the question is, should the regulators ease their regulation on banks?