2. A con artist has a great idea: he’ll open a bank without investing any capital and lend all the deposits at high interest rates to real estate developers. If the real estate market booms, the loans will be repaid and he’ll make high profits. If the real estate market goes bust, the loans won’t be repaid and the bank will fail—but he will not lose any of his own wealth. How would modern bank regulation frustrate his scheme?
The aspects of modern bank regulation that would frustrate this scheme are capital requirements and reserve requirements. Capital requirements mean that a bank has to have a certain amount of capital—the difference between its assets (loans plus reserves) and its liabilities (deposits). So the con artist could not open a bank without putting any of his own wealth in because the bank needs a certain amount of capital—that is, it needs to hold more assets (loans plus reserves) than deposits. So the con artist would be at risk of losing his own wealth if his loans turn out badly.