Politicians, bank regulators, supervisors and central bankers the world over have spent close to 10 years trying to eradicate the root causes of the 2007–08 global financial crisis. Bank leaders have spent the same period trying to modify and mould the structures and profiles of their institutions to meet the requirements and obligations of what has become a veritable regulatory onslaught.
But has the regulatory tsunami started to lose its most potent force, as unintended consequences are finally acknowledged, and as populist tendencies to exact retribution for banks’ role in the financial crisis fade over time?
Donald Trump’s victory in the US presidential election and his espousal of light-touch regulation certainly set the cat among the pigeons and has led to intense speculation about what “light-touch” might mean for US banks; and for US engagement with global policymaking at the Basel Committee on Banking Supervision, the Financial Stability Board and indeed the G20.
It has also led to concern in Europe around what any moves to lighten the burden on already stronger US banks in an openly competitive deregulatory process might mean for the international competitive landscape.
With Dodd-Frank and the Volcker Rule back under the spotlight, the prospect of regulatory dissociation between the US and the rest of the world is casting a long shadow over regulatory developments elsewhere.
“We’re in an extremely tight regulatory era [in Europe] at a time when the economic backdrop is far from supportive and other jurisdictions are about to ease their constraints. This won’t be conducive for Europe and it isn’t competitive on a global basis,” said a credit portfolio manager at a major buyside firm.
Even before Trump’s shock election there were signs that the regulatory onslaught is losing force – and even at times reversing course.
In its broad package of proposed reforms to strengthen the resilience of EU banks unveiled on November 23 (but prepared before the US election), the European Commission was at pains to stress two aims: addressing outstanding challenges to financial stability at the same time as ensuring banks continue supporting the real economy.
For many of the intervening years since the financial crisis, those aims had seemed to have been treated separately as monetary and regulatory bodies took separate paths in mutual ignorance of each other’s actions and outcomes.
“The likelihood that banks will do a proper job, give a decent return to shareholders and continue to finance the economy will depend mainly on the skills of regulators,” said a senior executive at a European bank who is actively engaged in conversations with senior national and European regulators.
“Banks will be forced to adapt but the economy might suffer. Regulators need to know what they want; I’m not sure they do.
“If you ask regulators what their mission is, they’ll tell you they’re in charge of making the system safer. Fine, but in that case who’s in charge of making sure the economy is financed?,” he asked. “It will be down to private-sector banks. The EU wants to shift the financing of the European economy to the US model. Again, fine. But that will take 15 years.”
The realisation that there is a linear correlation between regulation and the transmission of money into the economy seems to have been a relatively recent phenomenon. Optically, it may always have been part of the narrative but it is now starting to seep into the fabric of the regulatory discourse and is increasingly manifesting itself through a dial back from the most extreme levels of regulatory burden.
“Europe needs a strong and diverse banking sector to finance the economy. We need bank lending for companies to invest, remain competitive and sell into bigger markets and for households to plan ahead,” acknowledged Valdis Dombrovskis, European Commission vice-president for financial stability, financial services and capital markets union, at the unveiling of the November reform package.
The EC said it wants to enhance the capacity of banks to lend to SMEs and to fund infrastructure; and that it is taking steps to make capital rules more proportionate and less burdensome around disclosure, reporting and complex trading book-related requirements (including around market-making) and reduce what it accepted was a disproportionate administrative burden for non-complex small banks on remuneration rules.
Brussels also wants to cut the costs of issuing and/or holding instruments such as covered bonds, high-quality securitisations, sovereign debt and derivatives for hedging purposes; and avoid disincentives for institutions that act as intermediaries for clients vis-a-vis trades cleared by central counterparty clearing houses.
This softer approach is consistent with other pronouncements. In the second annual report entitled “Implementation and Effects of the G20 Financial Regulatory Reforms”, published in August 2016, the Financial Stability Board said this:
“The FSB, in collaboration with the standard-setting bodies, continues to enhance the analysis of the effects of reforms. Policies will be adjusted where necessary to address material unintended consequences. Work is under way to address the conceptual and empirical challenges in evaluating whether the reforms taken together are having their intended effects on the financial system and the broader economy.”
It added: “The monitoring of progress, challenges in implementation and the adjustment of policy measures to address material unintended consequences represent good regulatory practice and form an important part of ensuring the accountability” of the FSB itself and individual standard-setting bodies.
And in its Action Plan on Building a Capital Markets Union, the EC noted: “Given the different pieces of legislation adopted over the past years and the numerous interactions between them, there is a risk that their collective impact may have some unintended consequences, which may not be picked up within individual sectoral reviews.
“Regulatory consistency, coherence and certainty are key factors for investor decision-making. If clear evidence is provided to justify specific and targeted changes, this could further help to improve the investor environment and meet the objectives of the CMU.”
Such realisations are important because the banking sector had been starting to resemble a one-dimensional utility zombie sector. It was becoming increasingly clear that over-zealous regulation was rendering the very business model of banking uneconomic.
Policymakers and regulators have seen ample evidence of banks grappling, existentially in some cases, with the realities of rewiring their structures, recalibrating their client and geographical footprints and their product offerings to meet the new set of rules. And doing so at the same time as upgrading their governance and transforming their cultures, all in a manner that underpins sustainable profitability and offers shareholders a decent economic return.
By the time the current regulatory vintage has run its course, the 10th anniversary of the collapse of Lehman Brothers will have come and gone. MiFID II/MiFIR is not set to come into effect until 2018, for example, while the final phase-in of Basel III is not until 2019. This by definition excludes work streams that have been initiated but not finalised, such as the broad sweep to Basel IV and the impacts of standardised RWA modelling and calibration.
Regulation by its very nature has to ebb and flow with the vagaries of the institutions it is intended to regulate and the markets served by the institutions regulated. The more conciliatory regulatory tone is likely to have evolved on the back of much more robust levels of bank capital and liquidity – even if risky interconnections in the banking industry are still more entrenched than regulators would like.
The message that seems to have been received is that onerous capital adequacy, leverage, liquidity, funding and resolution metrics; a shift to standardised RWA modelling; and changes to strategic and business models to take account of the new realities are, in the round, so arduous and debilitating that they put the patient into a deep coma.
Banks are shrinking headcount and balance sheets, ditching business lines, exiting geographical locations, shrinking client footprints, altering client service levels; changing legal structures, hiring armies of compliance staff and spending billions on regulatory fulfilment.
Banks have by definition to be risk-takers. Not in the sense of engaging in highly-leveraged proprietary trading in “casino” investment banks but in economically-beneficial risk-taking around consumer, small-business and corporate lending.
We may be at an early stage but with regulators having hugely strengthened the banking sector since 2008, it is reasonable to expect the role of regulation to recede.
And rather than killing the patient, it is necessary to enhance the role of banks as key economic agents. When all is said and done, the focus needs to be on giving end-users genuine choice in their access to working capital and investment funding.
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