Debt Cap Rules and Ethics: Balancing Stability and Inclusion

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Financial crises have a long history where swindles and frauds feature strongly in the credit-fuelled “manias” which precede them (Kindleberger & Aliber, 2005). The meltdown after such crises reveals morally questionable practices, and those engaging in them – typically bankers – are brought to the forefront of public attention and academic analysis. However, this emotionally-heated dialogue blurs the lines between two distinct issues:

1. how different financial institutions treat their own customers;
2. to what extent individual banks are responsible for the outbreak of a financial crisis with severe macroeconomic consequences.

This paper focuses on the latter question.

The study argues that the decisions faced by financial institutions sometimes reflect the tragedy of the commons (Hardin, 1968), which is a metaphor for the conflict between individual and collective rationality. Just as the cattle in the analogy graze more and more of the pasture, increasing lending uses up more and more income in the economy. Just as it makes sense for individual herdsmen living around the pasture to send an increasing number of cattle to the field, under certain conditions the decision-makers at individual financial institutions may feel that lending more and more is rational, even if they have to loosen credit conditions to do so, thereby generating risks for the whole system.

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