were to occur, it would not be possible to liquidate this debt. It has also been suggested that the real effects of a banking collapse are felt in the macro-economy. Quinn suggests that the banking collapse of the 1930s has severe effects on the ‘depth and duration of the Great Depression which followed’ (Quinn, 1992). Combined with the lack of motivation on depositors’ behalf to monitor and screen banks, there is a clear case for government intervention. The other primary reason for market failure in the banking system lies in the provision and screening services that they provide to offset informational problems. The relationship which requires the most attention is that between the depositor and the bank. A depositor cannot distinguish between a bank that has a high risk strategy or has a low risk strategy and since deposit rates must reflect average risk then a bank which follows a high risk strategy is hidden. The misallocation of resources which ensues may lead people to believe that individual deposit rates should be applied to each different bank reflecting their riskiness. In fact,"such differential deposit rates will be undermined by the public good nature of the evaluation and monitoring of banks" (Quinn, 1992). A very strong argument exists against Government intervention. In most of the other industries in our economy, there is quite a lot of transparency for consumers regarding how risky it is to buy goods and services and therefore, would it not be better to allow the public to deal with the informational asymmetries inherent in the banking system. One particular response to this problem of unidentifiable risk has been to impose flexible capital adequacy ratios. (Bank of International Settlements (BIS) and EU)."increasing the ratio of own capital to total capital as a means of ensuring bank solvency" (Stewart, 1996). This ratio has three different effects. (1) Since the capital asset ratio has been reduc...
