In the US, bank failure rate has increased after putting in place safety net policies. Economists argue that poor design of safety net policies, political compulsion and inaccurate judgment about the environment are the major culprits. Economists are also worried whether Basel II will be able to strengthen the system because discretionary powers in the Internal Ratings Based (IRB) approach of credit risk may increase the appetite of banks for risk. There is need for a public policy which focuses on the causes of problems and enhances the macroeconomy stability.

Banks are now more vulnerable than they were in the preregulation regime. This has been pointed out by several economists through the example of the banking system in the US. In the US, bank failure rates increased to 1.09% (1914-1994) from 0.91% in the pre net safety regulations period imposed on the banking system by the Federal Reserve in 1914. The failure rate, in the banking system increased, despite a fall in the failure rate from 1.0% to 0.65% in non-bank firms. It is not that other countries will experience the same problem, but it is very difficult for regulators to put in place the right safety net policies due to political compulsion or weak understanding of the environment.

In general, it can be concluded that bank failure is difficult to attribute to poor market discipline or increased instability of an economy. Higher failure rate is only due to poorly-designed safety net policies of the regulators, which lead to moral hazards and agency problems. Mark Flannery (1995) came up with the conclusionhe believed that poorly designed policies of the supervisors had increased bank failures. Some economists are also speculating whether the implementation of Basel II regulations will reduce the bank failure rate. Doubts are not subjective because banks will adopt the advanced risk management practice whether they will genuinely hold appropriate risk capital.

US, bank failure rate, Economists, political compulsion, environment, major culprits, Internal Ratings Based approach, credit risk, public policy, macroeconomy stability, preregulation regime, banking system in the US, Federal Reserve in 1914, non-bank firms, poor market discipline, economy, moral hazards, Mark Flannery, Basel II regulations, advanced risk management.