Financial regulation: passing the bucks
The lack of any principle behind banking rules is short-changing everyone.
Banks have decided that they like regulation after all. The red tape supremo at the Financial Services Authority (FSA) complains that banks ‘bleat’ about regulation, but then they oppose attempts to reduce the regulatory burden. (1)
The spat has arisen because the FSA has proposed to relax draconian rules about ‘approved persons’, the senior managers whose roles are thought to be so sensitive that they require specific individual regulatory approval. The FSA currently holds files on the career history and disciplinary records of around 10,000 approved persons. Their proposal is that the banks should take responsibility for ensuring that their managers have the knowledge and responsibility to do their jobs. This has inspired furious protest from the banks.
The banks are afraid that this will be an excuse to blame them when anything goes wrong. Prescriptive processes are said to be preferred, because responsibilities are clear. If banks are held accountable, they could incur huge fines because the regulator retrospectively thinks that their procedures were weak. The FSA stands accused of passing the buck, of evading responsibility for the regulatory process by handing it over to the banks. The banks still insist that they are against the current costly and inefficient regulatory regime, but their denials ring false.
The truth is that banks like regulation. It imposes common costs across the industry, which raise the cost of doing business, but these costs are spread more or less evenly. It makes it expensive for new entrants, because they have so much complex regulation to master. But it does little harm to incumbents – in fact, it protects them from new competition. The bigger banks can spread the costs more widely, so it might benefit them even more than smaller players.
Within the banks, well-paid specialists manage so-called ‘regulatory risks’, and have an interest in ensuring that they keep their jobs. And the more strict the regulation, the easier it is for banks to wriggle out of responsibilities by insisting that they have ‘followed the rules’.
The FSA is also at fault, because it regulates indiscriminately. Customers have to take in myriad forms of identification to open a bank account, making it more of a hassle to shop around and imposing huge costs to manage the process and control the paperwork. There are detailed regulations governing what banks have to report to the FSA concerning the complex financial derivatives they transact.
But no one is taking an overall view of the risks that society has an interest in controlling, from consumer protection to financial stability. Indeed, financial stability, perhaps the greatest public concern, is outside the FSA’s remit – it is still the responsibility of the Bank of England, which has a much lower regulatory profile in the industry.
There is a dual failure. Banks fail to defend their professional ability to manage the risks of their business pragmatically, defend their interests against the regulator, and take responsibility for failings. However, the banks’ fears are justified; huge fines have been imposed where the FSA deemed internal procedures to be flawed. It is rather late in the day for the regulator to see the advantages of letting managers manage.
Above the banks and the regulator, politicians introduce arbitrary concerns, elevating concerns about money laundering one day, and fighting red tape the next (2). There is an atmosphere of uncertainty that makes a preference for the tried and tested understandable, even if it is indefensible.
Meanwhile hedge funds, the focus of media fears, are thriving precisely because of the confusion. In effect they act as regulatory arbitrageurs, reaping the rewards of fast-moving financial markets without the burden of the regulatory controls that banks face. They risk only the funds of their rich investors, and the banks they deal with, and their funding is from sophisticated investors, which means that they don’t need to follow detailed rules about consumer protection. There are rich rewards outside the box-ticking world of the big banks.
The trouble is that no one is taking a principled stand on either side. To favour unrestrained free-market capitalism is to be a heartless brute. To propose central planning and organisation makes you a naive dinosaur. But when pragmatism is elevated to a general principle, bureaucratic confusion results. The most narrow and trivial bureaucratic interests have been allowed to trump the general interest in efficient and effective regulation. No one is taking responsibility for ensuring a coherent regime that assigns responsibilities appropriately.
Both sides are passing the buck. As a result, customers are inconvenienced, innovation is stifled, and the allocation of capital is distorted by arbitrary rules. And that really is something to bleat about.
James Greenstein is an investment banker in the City of London who has worked in a number of different risk management roles.
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