Mon, Aug 28, 2017 - Page 7 News List

Regulators need to be accountable for their creations

Rather than understanding the risks run by their institutions, bankers rely on the rules they are given — but these often disappoint

By Antonio Foglia

The global financial crisis that began in August 2007 resulted from a massive, unavoidable cognitive mistake on the part of regulators and bankers. It is now 10 years later, and yet few are willing to admit this fact, let alone explore appropriate remedies.

In fact, the opposite has happened: Regulators have piled on ever-more complex rules, and too-big-to-fail banks have become still bigger. Even worse, the wrong-headed response to the crisis threatens not just the financial sector, but open societies generally.

To be sure, the financial crisis had different catalysts in different countries, including subprime loans, real-estate bubbles, sovereign debt, and economic downturns that affected small and medium-size enterprises.

However, there was also a common denominator: a structural weakness in the banking sector — already one of the economy’s most regulated sectors — that left highly regulated banks unable to withstand economic perturbations as well as unregulated financial institutions.

According to a 2012 study by Andrew Haldane of the Bank of England, the financial crisis caused failures in about half of the 101 banks with balance sheets larger than US$100 billion as of 2006.

The vast majority of these banks, including Lehman Brothers in the US, had not breached any of the prudential regulations already in place before the crisis.

Moreover, 11 had already met the capital requirements that are currently being introduced as part of the new Basel III regulations, and yet four of those 11 still failed.

These findings imply that the new post-crisis rules are inadequate. For more proof, consider Spain’s Banco Popular, which passed the European Central Bank’s Asset Quality Review in 2014 and the European Banking Authority’s stress test last year.

As of December last year, Banco Popular still had a tier 1 capital ratio of more than 12 percent, which is only slightly below average and 50 percent above the minimum requirement.

Six months later, it went bankrupt, wiping out many bondholders’ assets along the way.

Despite such red flags, few have demanded an explanation from financial authorities for why the new regulations are falling short. As a result, Mark Carney, the governor of the Bank of England and the chairman of the Financial Stability Board (FSB), had no problem boasting in a letter to G20 leaders last month that “the largest banks are required to have as much as 10 times more of the highest quality capital than before the crisis.”

This claim, whether true or not, points to a serious mistake before the crisis that has not been sufficiently investigated, much less corrected.

The capital of the top 55 US and European banks has about doubled since 2006, both in absolute terms and relative to risk-weighted assets.

However, despite the Banco Popular episode, bankers on both sides of the Atlantic are lobbying for the new capital rules to be relaxed further, and for permission to increase leverage and returns.

Why are regulators and bankers apparently seeking to double down on their mistakes?

For starters, banking authorities never adequately investigated their own role in the previous crisis, because they had no incentive to do so. On the contrary, they jumped at the opportunity to hide their responsibility when disoriented politicians blamed other non-bank financial activities, which they have misnamed “shadow banking.”

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