So are private development and enforcement of capital and liquidity standards. Financial institutions have strong private incentives to create their own clearing system, to benefit both banks and the public. In creating such a system, the institutions develop standards for capital, liquidity, and prudential management that will become requirements for membership in the system. There are private alternatives to deposit insurance or to a central bank to maintain confidence in and foster the stability of the financial system. Sophisticated note and deposit contracts are feasible.
Free entry is important to encourage innovation.
Branching and portfolio diversification can substitute for deposit insurance, to stabilize the banking system. An explicit central bank may not be needed, but rather mechanisms to provide added liquidity, perhaps through the clearing system, in times of trouble. The full report is available on our FTP server.