Time to call a halt to regulatory overkill

…and why even Archbishop Welby agrees

None can disagree with the need for a regulatory transformation of the banking sector following the 2008 financial crisis. Yet after seven years the blitzkrieg of rules continues amidst a confusion of overlapping and contradictory requirements. It beggars belief that the rules on too big to fail were only agreed in principle in November last year by the G20, while the details have yet to be made final.

Speaking to bank CEOs and Chairs in the UK and Europe, who dare not complain publicly, the regulatory fatigue that Bank of England Governor Mark Carney spoke of is apparent, as are a number of the unintended, negative consequences.

Capital has become local as global banks withdraw to their home markets. Surpluses of capital are not being used, while demand lies unfilled. When you add in Anti Money Laundering and Counter Terrorism requirements, even long-standing, legitimate businesses in Africa are having their bank accounts closed down. Let alone HSBC’s strategically absurd decision to exit Brazil, still responsible for approximately 60% of South America’s GDP, and to do so at the worst time possible time, when the country is in the doldrums.

Secondly, loan capital has diminished substantially. The creation of credit is a problem. And which sector or instrument that credit goes to is determined by regulatory requirements rather than business sense. This can itself lead to a new crisis.

Competition has contracted, with banks either going bust or being absorbed by others, while regulatory requirements have increased the barriers to entry. As the latest results from the big US banks testify, only the large can absorb regulatory burdens and fines. JP Morgan has moved from being a big financial institution pre-2008 to bestriding the world like a colossus. There are some so-called challenger banks – new entrants unencumbered with the legacy of old systems and debts – while internet-only loan providers are growing at a dizzying pace, but it will take a very long time for them to fill the gap, if they manage to do so.

Fourthly, the myth that Brussels is responsible for myriad new rules is helping push the UK out of the EU. In fact, with regulatory equivalence, the UK would not escape more regulation even if it did leave the EU.

Lastly, even as banks cut down on front line staff, there is a vast increase in their recruitment of compliance specialists, as well as the information technology personnel needed to change systems to comply with new rules. Regulators are asking for the traceability of all credit decisions, even the smallest, all of which consumes management time. Top bank executives complain that they spend hours in meetings with junior, inexperienced supervisors who have never worked in banks and are more intent on protecting themselves from criticism by painfully ticking every box.

Complexity is not progress.

At board level the situation is no better. Bank board meetings are about the modelling of risk, rarely about strategy or how to grow the business, according to board members. One FTSE-100 financial services institution conducted 29,000 different simulations. The Non-Executive Director in charge of the Risk Committee was dismissive of the exercise. Meanwhile, potential NEDs with insight and experience say that you would have to be “reckless” to jeopardise a 30-year career by taking up an appointment on a bank board – even more so if criminal liability is extended to independent directors, as has been proposed in the UK.

The Bank for International Settlements, the so-called central banks’ bank, recently said the wave of regulation is coming to an end. Bankers disagree.

Seven years after the financial crisis, regulation needs to focus on being an enabler of financial services rather than an obstructer. To change the mind-set of the regulators – and the bankers – a system of secondment needs to be set up. Modelled on the very successful Takeover Panel, which has been ruling on mergers and acquisitions in the UK since 1968, bankers would be seconded to regulators for a pre-agreed period, with their salaries paid for by the banks. This is idea has been mooted before in the Salz Review of what went wrong at Barclays Bank, but sunk without trace.

On the macro front, the focus should shift to stimulating the capital markets so that the provision of credit does not lie mainly on bank balance sheets, as it does in Europe, while capital requirements should be lowered and the focus should shift to the leverage ratio.

Speaking to the Worshipful Company of International Bankers a couple of months ago, the Archbishop of Canterbury, Justin Welby said: “2008 continues to lurk around as an impediment, which undermines confidence. Creativity and confidence go hand in hand…Creative leadership that does more than manage is essential.”

It is time to move on.

This column is based on private conversations with bank CEOS, Chairs and board members in Europe, as well as knowledge gained in my prior career as Senior Editor of The Banker and a former banking columnist for the International Herald Tribune.

It will be published in the next issue of Dialogue Review.

The Tale of a Whale

The precariousness of JP Morgan Chase

The New York tourist sitting next to me with the map of London spread out on his lap asked where he could find the London Whale. Seriously. Unlike the London Eye, I told him, the London Whale was a human being, albeit a metaphorical landmark.

The London-based JP Morgan Chase trader’s nickname derived from his large positions in the credit market, which in the summer of 2012 resulted in the bank declaring a $5.8bn loss. It subsequently faced major fines from both the UK and US regulators for, among other things, its lax supervision and for not “adequately updating” its audit committee on the findings of an internal review, in the words of the Securities and Investment Board (SEC). The bank agreed to around $20 billion in legal settlements in 2013, almost equal to a typical year’s profit, for a range of misdemeanours.

Bereft of its gobbledygook, SEC’s phrase can be translated as “deceitful behaviour.” In other words, culture.

A recent survey highlighted that two thirds of global banks agree that a big part of the financial crisis was due to culture but only one third of banks thought there was anything wrong with their culture (my italics).

Transforming an institution’s culture is a lengthy journey, rather like chasing Moby Dick, the symbolism-laden whale in Nathaniel Hawthorne’s classic book of that name. As well as obvious factors like overhauling compensation, banks need to exercise integrity through sound judgement and rewarding decision-makers who have the guts to say no.

A very sensible suggestion on culture put forward in the Salz Review (an assessment of what went wrong at Barclays Bank pre and post the financial crisis ) was for bankers to spend two years on secondment to the financial regulator and vice versa. It appears to have sunk without a trace, despite the fact that there is a model for how to do it in the Takeover Panel, the UK’s M&A regulator, which regularly hosts top bankers and lawyers who then return to their firms.

Box-ticking is not the way forward. Unfortunately, though, the plethora of rules spewing forth from different regulators, like water from a whale’s blowhole, makes it overwhelmingly necessary. How else can universal banks active in a number of countries deal with the US’s Volcker Rule, the UK’s Vickers, the EU’s Liikanen, let alone Basel III, which appears to already be disintegrating? In fact, each country seems to be setting its own rules and banks are retreating home, capital in tow.

To add insult to injury, no sooner have banks complied with a rule that the regulator changes it. The Basel Committee admitted this autumn that perhaps securitisations per se were not “bad.” Without saying it in so many words, the implication was that forcing banks in 2009 to post higher capital requirements against them – as though all securitisations were similar to sub-prime mortgages – was wrong. The Committee is set to review the issue sometimes in 2014.

Meanwhile, the absurdity of zero or very low capital requirements on holding sovereign debt has steered banks to load up on it. This may be very useful for over-indebted governments, but as Jens Weidmann, President of the Bundesbank noted late last year, “the current regulation’s assumption that government bonds are risk-free has been dismissed by current experience.”

In truth, it doesn’t take familiarity with the last few years to realise that ‘risk-free government bonds’ has always been an oxymoron. In the best of cases their value has been damaged by inflation or currency devaluation; at the worst it has been destroyed by restructuring or default.

Moby Dick evaded his pursuers, but most of the crew of the Pequod, the whaling ship, met their death because they dared not stand up to Captain Ahab and his lack of judgment.

JP Morgan Chase’s Chairman cum President cum CEO Jamie Dimon – yes, truly three titles – admitted a few weeks ago that some investigations into the bank were just beginning, which does not bode well for 2014 results.

In May Mr Dimon fought off a shareholder revolt that would have seen him lose his position as chairman by letting it be known he would walk from the bank if this happened. The blackmail worked. He kept his triumvirate of titles and continues to lead the largest bank in the US.

This is a sell notice. It has the same whiff of omnipotence that marks the reigns of presidents who succeed in changing constitutions to allow them yet another, and another, and another term in office.

The Pequod had a problem of culture. We shall see how the tale unfolds for some of the banks, not least JP Morgan Chase. But the omens are not good: absolute power really does corrupt absolutely.*

*This column originally appeared in The Dialogue Review, an academic journal.