Banks do not really exist. They are constructed. Banks are always and everywhere determined, defined, and constituted by the legal permissions they are given by whichever the public authority may be: Royal Charter, Act of Congress or Parliament, or regulatory rules of thumb, preference or requirements. Differently to a physical good or type of service which does exist outside of its regulation (for example a haircut or legal advice), banking is not an activity or object on which regulation or rules can be imposed but rather one which is created by these regulations, rules and requirements. Change the rules, change the activity, change the bank.

These rule-changes – and therefore the changes to what banks do and so what banks are – happen all the time. And for various reasons. Banks, like any profit-maximizing institution, will always try to innovate beyond their explicit permissions so that they can increase their returns. By definition these new activities are outside the original scope of the banking regulation. Public authorities have a choice: to try to fill this regulatory gap or to leave it. So regulators often change rules to bring these new activities that banks undertake into their scope.

Sometimes banking regulation changes because political ideas change and so what society at large wants from its banking sector changes. Sometimes there is a greater focus on the safety of the sector, sometimes on its competitiveness, sometimes on its contribution to national production, and sometimes on the ease of access for consumers. There could be any number of political aims for the banking sector. When that changes, so do the rules imposed on banks and thus what banks can do: and what banks are.

But one thing that banking regulation does not seem able to provide is financial stability; even though this is frequently (perhaps always) stated as one of its core objectives. Despite frequent regulatory change, financial instability persists. This book argues that this is as a result of the regulatory nature of banking, of the fact that banking is constituted through regulation but operates in the market.

Banking regulation is created for political reasons (in its broadest sense) but banks operate according to market principles – in other words the attempt to maximize profits within a structured market. The gap between political inputs and market outputs is where financial instability springs up.