Aligning Bank's Risk Appetite to that of Depositors

 Time and again, we come across situations where large banks incur huge losses due to some poor bets or lack of asset liability matching. As a result, we have unintended consequence of the financial economy pulling down the real economy and common people getting impacted due to no fault of theirs.

An equity investor or a mutual fund investor has a reasonable idea of the risks involved in the markets. She understands that there are downside risks involved in equity or mutual fund investments. So it is safe to conclude that an equity investor(mf investor) is more risk taking than a bank depositor. A bank deposit holder is far less risk-taking when compared to an equity investor. However, we notice that depositors run into trouble to risk taking activities of their banks.

One solution to this problem,(apart from stringent disclosure requirements, capital requirements and regulatory supervision) is to align a bank's risk profile with that of depositors' risk profile. So while making a deposit with a bank or financial institution, the customer indicates where she would want her money to be invested - low, medium or high risk investments/projects. Then the bank can pool the deposits as per their maturity as well as 'customer- risk-appetite' buckets and choose their projects accordingly. A depositor who is unsophisticated and lives on small incomes may not be interested in high risk investments and the return expected is also commensurate to the risk appetite. Similarly, a tech startup may have some preferences in terms of where it's money is parked.

The result of such a classification would be a fall in banking profits but we can at least  avoid these periodic blow ups which threaten to take down the entire system.

Regulatory requirements always seem to be behind the curve and cannot prevent banking crises. And each time the tax payer has to come to the rescue, either in the form of bailouts or deposit insurance.

If an equity investor has the right to choose her risk appetite, shouldn't the depositor have a right to choose her risk appetite?

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