Financial Crises and Banking Regulation

For me, I do agree that there’s still the need to implement regulations for intermediaries to have sufficient capital adequacies despite of not optimizing allocations. Yes, it is true that each one has his or her preference on how to maximize their allocation. In fact, one may find it more logical to optimize allocation even if the downfall of this may lead to defaulting or a financial crisis. However, as I have said, each has his or her own preference for risk. Not all has the inclination or the appetite for such extreme risks. Even if it will optimize allocation, one cannot deny the fact that some will still want to play it safe and settle for smaller returns. This now becomes the problem of intermediaries. How do they cater to all of the preferences of its depositors and is having a regulation to maintain capital adequacy the best solution given that it limits the intermediaries from attaining optimal allocation?

One may think that it is always best when you get the most of something. In the same way, one would think that having the optimal allocation is best for everyone even if the downside of it is a financial crisis. Though I agree on this in some point, I have to say that it is not the actual best solution for everyone. Yes, having the most returns is beneficial for almost everyone if not all but the consequence of having a crisis is probably not as appealing as getting the optimal allocation. Financial crisis can be good if probably we have a perfect market as Modigliani and Miller would see it. But in our world, our market is not as perfect as one may think. There are costs related to the imperfection of our markets. Therefore if our banks default, there are costs to this. If one bank goes bankrupt, it is not only that bank which goes bankrupt, some other banks are also affected by this, directly or indirectly. Now if our banks fail, our economy as a whole also fails. The cost of having a failure in the economy probably outweighs the benefits of...