Gone with the wind

There is no shortage of ideas on how to reform financial regulation. But so far policy-makers have failed to adopt genuinely radical solutions to avert a repeat of boom and bust

  • By Phil Thornton
  • 03 Oct 2009
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De-regulation is dead. Twenty years after the fall of the Berlin Wall, financial laissez faire has joined communism in the graveyard of failed ideologies.

After the worst financial crisis since the Great Depression, it is hardly surprising that the debate is over how, rather than if, financial institutions and bankers should be more tightly regulated.

There has certainly been no shortage of ideas. US president Barack Obama and his Treasury secretary Timothy Geithner spelt out a tough new approach in a report entitled A New Foundation. Jacques de Larosiere, the veteran French civil servant and banker, wrote a report for the European Commission proposing the creation of a systemic risk council to spot impending crises. In the UK, one of the worst affected victims of the crash, Adair Turner, chairman of the Financial Services Authority, has floated the idea of a global tax on financial transactions to “eliminate excessive activity and profits”.

Finally, after a lot of political bickering, leaders of the largest economies drafted an overarching vision at the G-20 finance ministers meeting in London and reinforced it at the summit of leaders in Pittsburgh. It covers a vast range of measures, notably tighter capital standards, stronger regulation for systemically important firms, and rules on pay that do not encourage risk taking.

“We have made substantial progress in delivering our ambitious plan, which will ensure a robust and comprehensive framework for global regulation and oversight,” finance ministers said in London.

Not so sure

Not everyone is so impressed. “While there’s a lot of talk about regulation, they are not getting on with it,” says Raghuram Rajan, a former chief economist at the IMF and now a professor at Chicago University.

Simon Johnson, Rajan’s successor at the IMF and founder of the much-watched Baseline Scenario blog, sees little more than “small changes”.

“What will really change in or around the power structure of global finance – as it plays out in the United States, western Europe or anywhere else? Nothing.”

He cites as evidence the lack of massive PR campaigns against the proposals from the leading financial institutions whose well-oiled lobby groups typically waste little time crying foul.

“Unless and until our biggest financial players are brought to heel, we are destined to repeat versions of the same boom-bust-bailout cycle,” he says. “If you find a government willing to state this problem clearly and really take action to confront the relevant powerful people, let me know.”

The Institute for International Finance (IIF), which represents 400 global finance houses, says the notion of reckless financiers is one of the many “caricatures” used by the industry’s critics. “One of the caricatures is that we are opposed to reform, opposed to high capital requirements, opposed to lower leverage, opposed to transparency and opposed to macro-prudential regulation,” says Charles Dallara, the IIF’s managing director.

“In fact, important and substantial changes [by banks] have taken place and are taking place: reduced leverage, prudent lending practices, $650 billion of capital raised, strengthened business models, improved governance and better risk management.”

Stephen Lewis, an economist at Monument Securities in London, says the G-20 can hardly be blamed for spinning the reform process out. “They do not want lenders to have to meet tougher capital requirements as long as economic conditions remain fragile,” he says. “After all, lenders might meet the more stringent requirements only by scaling back their lending.”

While the G-20 – and the Financial Stability Board (FSB) that drew up the detailed plan unveiled at Pittsburgh – work on their vision, it is up to national governments to put in place legislative changes needed in their own jurisdictions. And national measures have to fit with a country’s individual circumstances and the deep-seated ideological preferences of its electorate.

Key issues

The three key issues that ministers must tackle are: capital requirements and liquidity standards; supervision of cross-border resolution of systemically important firms; and the whole issue of remuneration for financiers.

Many fear the high-profile arguments, such as those on capping bonuses, make a global deal hard to reach. “There could be a significant improvement in coordination,” Dallara says. “The bulk of what has been done over the past two years on regulatory reform has been done in an uncoordinated, nationally driven fashion.”

This fragmentation has many symptoms. Proposals to curb bankers’ pay are a key area where countries have diverged. France has adopted unilateral rules on bankers’ pay, while Britain and America believe restricting banks’ risk-taking activities will do the same job indirectly.

The G-20, as a sop to France and Germany, asked the FSB to “explore possible approaches” to capping performance-related bonuses.

Peter Hahn, a former senior corporate finance officer at Citigroup and now a Fellow at City University in London, says France is going down the wrong track. “Pay is a symptom; it is not a disease,” he says.

But Joseph Stiglitz, Nobel laureate and professor at Columbia University in New York, believes the French have taken the right approach. “The French government and some of the other European governments have shown more resolve to do something about the compensation problem,” he says.

Rajan says the problem is that the proposals range from the “very light to the draconian”. “It is not clear that the people who have thought about the draconian stuff understand whether this will resolve the problems seen during the crisis or whether the only point is merely to get at the bankers themselves, cut them down to size because they hate banks,” he says.

Leverage ratios

Another area of disagreement is over leverage ratios: a cap on the amount of debt an institution can hold relative to its equity. Geithner has proposed a “simple leverage constraint” that would act as a “hard-wired dampener” on unsustainable risk-taking. Continental Europeans on the other hand want leverage seen as part of a risk-based approach and included under the so-called pillar two of the Basel II accord, with flexibility to impose tighter rules on different banks.

Speaking for the big banks, Dallara praises the European option. “Leverage is a blunt instrument,” he says. “Leverage with a balance sheet full of Treasury bills and European government bonds is very different from a balance sheet full of highly complex derivatives.”

Leverage ratios are just one part of requirements for banks to hold more and better quality capital. This is a central element of the US and UK plans. A new US Financial Services Oversight Council would apply tough capital, liquidity and risk-management standards to large, high-leveraged or complex organizations whose failure would threaten the stability of the whole system.

Capital requirements

Geithner has set out a detailed proposal for a new capital requirements regime that includes eight “core high-level principles”. He said the Treasury would strike a balance between “absolutely essential” higher capital requirements needed to underpin financial reform and “unduly curtailing credit availability and financial innovation”.

British chancellor Alistair Darling is instructing the Financial Services Authority (FSA) to place higher capital requirements on banks with higher requirements for those involved in “riskier trading activities”.

However, there are no detailed proposals on the table and no imminent sight of any. Geithner has said that countries should achieve a comprehensive international agreement on a new global framework by the end of next year, with implementation of the reforms effective by the end of 2012.

Stiglitz says the devil is in the detail. “There are statements like ‘we are going to order more capital for larger institutions’, but until we see how much more capital we won’t know whether it will bite,” he says. “Until we see the details, we won’t know whether this is just a cover-up or whether it is meaningful.”

Rajan warns against setting levels of capital that guarantee against failure. “The levels of capital you would need to prevent failure would be totally enormous, and asking banks to hold those levels of capital could mean a doubling of capital requirements,” he says. “It might need a rethinking about whether people want financial intermediation. People act as if capital is a free good.”

Crisis resolution

The lesson of the collapse of Lehman Brothers on September 15, 2008 was that it is vital for governments to have a contingency plan for a failure of a systemically important institution – especially where its operations cross borders.

“Governments should not be left with the choice between chaos breaking out or bailing out a global financial institution. There is a third way and that is the development of resolution regimes,” says Dallara. “We need to begin our work with private and public sectors on cross-border crisis resolution regimes that are compatible and mutually consistent.”

The UK designed a Special Resolution Regime in the wake of the Northern Rock fiasco and put it into operation to rescue the Dunfermline building society. Darling is also considering whether to force banks to make ‘living wills’ to make it easier for the authorities to dismantle failed firms. The US is pursuing the same idea.

The European Commission is also struggling with how to oversee rescues of banks that may operate in several small member states but be based in one – the so-called home/host problem. The de Larosiere report noted there were no EU-level mechanisms for financing cross-border crisis resolution efforts, but concluded only that member states should agree on “more detailed criteria for sharing the financial burden”.

Dallara says this is a crucial issue. “What kind of burden sharing [is there] if a subsidiary in country A of a host bank in country B fails? We need to work towards a system,” he says. “It is ambitious, but it is necessary. In their absence you have a tendency towards fragmentation and policies designed to protect one country rather than protecting the system as a whole.”

While coordinating 20 governments may seem hard, for US president Obama the stiffest opposition may be at home. He plans to strip the Securities and Exchange Commission of its role as the bank rescue agency and pass it to the Federal Reserve, which also takes on payment and clearing system oversight. This has angered some in Congress who believe the Fed is being beefed up without acknowledgement of its role in inflating the asset price bubble.

Meanwhile a new Consumer Financial Protection Agency that will protect consumers and investors from financial abuse is being resisted fiercely by mainstream banks.

The American Bankers Association (ABA) believes reforms aimed at curbing the excesses of the non-banking institutions will harm the wider economy. “The Administration’s proposal is so vast and controversial that it will be extremely difficult to enact and will produce great uncertainty in the financial markets and among financial regulators while it is pending,” says Edward Yingling, ABA’s chief executive. “Thousands of banks of all sizes, in communities across the country, are scared to death that their already-crushing regulatory burdens will be increased dramatically by regulation aimed primarily at their less-regulated or unregulated competitors.”

But Peter Hahn says these detailed arguments are a side issue to a bigger failure. Policy-makers have failed to adopt genuinely radical solutions to avert a repeat of boom and bust, he says. Governments need to break their dependence on the financial system and force banks to become smaller and more efficient.

“What the G-20 is really trying to do is smooth things over and take the easy option because they cannot think outside the box. The reality is that they need to reinvent the whole model,” he says.

  • By Phil Thornton
  • 03 Oct 2009

All International Bonds

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • 24 Jul 2017
1 Citi 253,106.92 930 8.89%
2 JPMorgan 230,914.50 1036 8.11%
3 Bank of America Merrill Lynch 221,389.46 762 7.78%
4 Goldman Sachs 171,499.26 554 6.03%
5 Barclays 169,046.60 646 5.94%

Bookrunners of All Syndicated Loans EMEA

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • 25 Jul 2017
1 HSBC 27,039.93 106 7.36%
2 Deutsche Bank 25,125.19 81 6.84%
3 Bank of America Merrill Lynch 23,128.33 61 6.29%
4 BNP Paribas 19,315.94 110 5.26%
5 Credit Agricole CIB 18,706.93 106 5.09%

Bookrunners of all EMEA ECM Issuance

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • Today
1 JPMorgan 13,488.13 59 8.47%
2 Citi 11,496.21 73 7.22%
3 UBS 11,302.86 45 7.09%
4 Morgan Stanley 10,864.95 59 6.82%
5 Goldman Sachs 10,434.21 54 6.55%