This degree of interconnectivity between the UK and the rest of the world is such that the IMF noted in 2011 that, “the stability and efficiency of the UK financial system is a global public good due to potential spillovers and thus requires the highest quality of supervision and regulation” 4. As a major host to international financial services activity, we are highly attuned to the importance of international trade and international banking to a successful world economy. Openness and trade support economic dynamism through many different channels. They promote efficient allocation of capital and risk, support greater competition, utilise comparative advantage, expand the size of the global market, and build economies of scale. 1  Why is the UK banking system so big and is that a problem? ; Bush, Knott, & Peacock; Bank of England Quarterly Bulletin 2014 Q4. 2  Prudential Regulation Authority Annual Report and Accounts 2015. 3  Foreign Banks in the US: A primer; Goulding and Nolle; November 2012. 4  Spillover Report on the United Kingdom for the 2011 Article IV Consultation; Country Report No. 11/225; IMF; July 2011. 2  BIS central bankers’ speeches  International wholesale banking has a critical role in facilitating these flows, contributing to the efficient allocation of capital globally, and so developing the world economy. Trade finance is of course essential to support trade. Deep global capital markets benefit savers and borrowers from around the globe. International banking also brings benefits, such as diversification of risks, efficiency, competition, and the advantages of specialisation.
And there is, of course – a limited liability company is basically a means of protecting its owners from the private consequences of the company becoming bankrupt. Being able to fund a business operation through borrowing is, of course, necessary and, in most cases, effective. In efficient markets, lenders’ risks are handled by means of interest rates and contract clauses. The limited liability company is thus a historically wealth-generating social institution. Nevertheless, the example illustrates that the higher cost of funding through equity is more a matter of private than social costs. Another factor that separates the costs for own and borrowed funds is the tax system. Companies may deduct interest on loans, but pay corporate tax for profits on equity. But this is just a private economic difference – from the social perspective, the only difference is the subsidisation of debt-financing in preference to equity. This specifically applies to banks that may be systemically important – it would be socially costly to allow them to file for bankruptcy. So the market often expects that the state will save a bank that is on the ropes, one way or another. These so-called implied guarantees create even greater differences between social and private costs, and risk leading the banks to take even greater risks. Banks are vulnerable, contagious and sometimes systemically important. There are great differences between private and social cost-benefit calculations. Economic theory and empirical experience gives us good reason to regulate banks.