Prudential Regulation and Capital Controls

Abstract

Michael Dooley makes a case for capital controls. He describes how the growth of international capital flows has increased the incentives by banks to choose high-risk strategies by opening the door to an almost infinite supply of leverage. He argues that the main problem with international investors when it comes to financial stability is that there are so many of them. It follows that limiting domestic financial institutions access to foreign investors can be an effective component of prudential regulation. In particular, he makes the case for required reserves on foreign deposits at domestic financial institutions.