Now that US regulators are getting down to business on figuring out which particular rules they can loosen, as demonstrated by Commodity Futures Trading Commission commissioner J Christopher Giancarlo’s comments to the assembled luminaries of the derivatives market (see back cover), it is important that it does not end up as a straight fight between bank bashers and the banks themselves.
There is plenty of latitude to get rid of absurdities without weakening the system. One example is the calculations for Reasonably Expected Near Term Demand in the Volcker Rule, which require traders to soul-search over whether, in their heart of hearts, they are taking a position. Another is operational risk capital, which calculates the risk of fraud or human frailty on a simple look at the recent past.
More importantly, bank shareholders are on board with a stronger system. Investors like banks with high capital levels, achievable and consistent RoE targets and modest inventories of hard-to-value structured assets. Volatile earnings and high gearing to the arbitrary swings in fixed income volume? Not so much.
After all, some of the biggest changes made in the name of regulation have been self-imposed. Incorporating capital and funding costs in the valuation of derivatives hurts the P&L for some trading desks — but gives bank management a better picture of risk.
Revamping risk and back office systems is costly, tedious, and painful, but banks have done this mainly for their long-suffering shareholders, not just to satisfy supervisory calls for data.
In this context, banks won’t run riot just as soon as a few hated rules hit the wastepaper bin. Time to give it a try.