This report presents an overview of the theory of regulation in general, with special attention for the regulation of banks. Two theories of government regulation are described. The first, normative, theory uses market failures as the justification of government regulation. The second, positive, theory explains the existence of regulation as the outcome of the interaction between politicy makers and pressure groups. The second half of the report is devoted to bank regulation. It is argued, that it is the combination of withdrawable deposits and illiquid, non-marketable assets that justifies regulation. The effects of regulatory policies in the form of deposit insurance, capital requirements, bank monitoring, bank closure policy as well as the optimal design of regulatory policy are discussed. From a first look at the practice of regulation it is concluded, that the theoretical recommendations are to a certain degree already applied in practice. Examples are risk-related capital requirements and deposit insurance premiums.
