Trying to make sense of banking regulation

In the past couple of months, there has been a lot in the media about regulating banks. First, the US government published its plans for changing the regulatory environment in USA [pdf], then the UK government set out its plans, and not wishing to be outdone, both the Conservative and LibDem UK opposition parties have got their word out, too, since there is likely to be a general election and potentially a new government before the Treasury’s proposals are implemented. Lastly, the European Union has done the same. [I’d love to post a link to the EU’s papers, but whilst I have found lots and lots [pdf] of responses to them, I can’t find any of their original publications. Sorry. The House of Lords’ European Committee report [pdf] seems to give a pretty good overview of the financial crisis, step by step.]

And the goalposts keep moving: last Saturday, Lord Myners, UK Financial Services Secretary, came up with some more, rather personal, proposals; this week, with the UK banks reporting halfyearly profits (or losses), the focus returns once more to banks’ reward and bonus structures (and that should be a post of its own…)

That’s a lot to get through. Fortunately, both the BBC and the Dow Jones Financial News website have provided summaries of the UK picture, and the Economist has lots about the US position as well as articles about the UK and EU.

To summarise, my understanding of all this is that some people suggest

  • creating oversight committees to manage regulation (UK government, US government, Conservative and LibDem parties, EU)
  • establishing “financial stability” as an objective for financial regulator [adding asset prices as well as inflation, as currently] (UK government, LibDems)
  • getting rid of the FSA (Conservatives)
  • disclosing what bankers get paid (LibDems, Lord Myners)
  • checking that banks meet conduct on exectuive pay (UK government)
  • increasing capital requirements for banks and other financial businesses (UK, US, EU, Conservatives, LibDems)
  • increase consumer protection (UK, US, Conservatives)
  • abolish tripartite regulatory system, handing power to the Bank of England (Conservatives, LibDems)
  • break up government-owned and other financial institutions (LibDems)
  • forcing Sir Fred Goodwin to do charity work (Lord Myners) – strange, given that Goodwin recently resigned as chairman of the Prince’s Trust. [Incidentally, friends at RBS have told me that their standard contracts have a clause stating that the pension rights of any former employees may be called into question if the former employee brings the bank into disrepute; it would have saved a lot of public hand-wringing and acres of newsprint if Sir Fred’s had, too.]

The EU appears to want to establish an Europe-wide regulatory body and to focus on hedge funds and private equity although there are
disagreements in EU about regulatory regime reflecting national interests and different world views.

Frankly, this all looks like “business as usual”. Because there were a lot of rules and regulations – and regulators – that banks had before the financial crisis; it is just that regulators didn’t necessarily do their jobs, and the markets didn’t realise it. Institutions failed to assess the risks they were taking, and therefore failed to price those risks properly and provide sufficient capital to cover their risks. And the markets failed to value assets properly as liquidity dried up.

Subtly changing the regulatory regimes in the US, the UK and the EU won’t necessarily change this; adding extra layers to the rich regulatory alphabet soup will make regulation more complex rather than simplify it. Scrapping regulators such as the FSA (the Conservatives’ proposal) and transferring their powers elsewhere may create turmoil in which further regulatory lapses may happen.

Increasing the capital requirements of financial businesses would enable them to cope better with future financial stresses, but will also reduce their willingness to lend money as they repair their balance sheets, at a time when governments are counting on bank lending to help the pull the world economy out of recession. The level of capital required will depend on banks adequately assessing the risks of the assets they hold, and there is no guarantee that they will do this better than they did before.

What no government seems to have thought fundamentally about is what their regulatory regime should set out to achieve, and what best structures would be needed to achieve that. Instead, they have taken their opening position and tweaked it – and done that pretty quickly, too. Raghuram Rajan proposes a radically different system; I have no idea if his ideas would achieve but I believe that there should be a greater debate about quite what the regulatory regime should set out to do, and how it should do it.

One thought on “Trying to make sense of banking regulation

  1. Pingback: Banks, bonuses and performance… « Patrick’s Blog

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