I have spent much of the last week involved in banking
issues, either talking with banks about their business plans or about them in the
context of the Money Macro & Finance Research Group annual conference. One
of the takeaways from the week is that insiders and outsiders, not
surprisingly, view the sector’s problems differently. Banks are concerned to
restore profitability and have outlined their business plans contingent on the current
legislative environment, which they believe is sufficient to strengthen their
institutions. Many academics and policy makers, on the other hand, want to make
banks even safer in order that the integrity of the financial system is
maintained and to ensure taxpayers are protected in the event of further
problems. Either way, it is a sign of the times that we spend so much time on
regulation issues today. A decade ago, financial stability was both a business
and intellectual backwater.
Looking at the big picture, there is still a lot of debate on whether the banking system is safe enough. Sir John Vickers, who chaired the Independent Commission on Banking, does not believe it is. Earlier this year he strongly argued that the ICB’s recommendations on capital adequacy had been largely ignored and that banks do not have nearly enough capital to withstand shocks. This is a view which the Bank of England does not share. Vickers’ argument is that although holding equity capital is costly for banks, because investors expect high returns, “high returns make sense only if they compensate for risk ... which is best done by more equity, not less.” In his view, the BoE argument that leverage ratios were ten times higher before the crisis means only that banks today are too risky versus stratospherically risky prior to 2008.
But whilst the argument is sound enough, John Kay points out that efforts to measure bank leverage, as required under the Basel III legislation, represent “bogus quantification.” We cannot adequately measure bank ‘riskiness’, and efforts to put a precise number on it give us a false sense of security. In any case, it is not as if banks were not regulated previously, as anyone who tried opening a bank account even prior to the crash of 2008 can testify. It is more the case that bank regulation was previously misdirected.
This highlights that there is a trade-off between the safety and usefulness of regulation. As Kay points out, the rising numbers employed in compliance represent a heavy tax on banking activity, and banks themselves are being forced to make costs savings in other areas to ensure they can meet the regulatory challenge. Ironically, we will only know that the outlays on additional compliance are being well spent if they prevent banks from incurring the wrath of the regulator. So the less they are in the headlines, the better. But since the actions of regulators on the other side of the Atlantic appear more as a capricious attempt at extortion, it may not matter how much banks spend if they are operating on a far-from-level playing field.
It is interesting when talking to banks about their business plans to note that they are taking a highly pragmatic approach. So long as they have a clear view of what they have to do, and the timeframe under which they have to operate, they seem broadly happy with where we are heading. Indeed, there appears to be a lot more certainty today than there was a year or two ago, when bankers complained that the regulatory goalposts were being moved far more quickly than seemed necessary. It would thus appear that, in the UK at least, the field of bank regulation is beginning to mature. In its early stages, bank regulation was focused on emergency balance sheet repair and there probably was an element of on-the-hoof policy making. Today, we are able to look forward with a bit more certainty, and I am also left with a sense that banks and regulators talk to each other more than they once did.
Macroprudential policy has thus become a key element in the policy armoury. There are some concerns that it may become a substitute for monetary policy – at least in part. For example, the regulators might prevail on banks to change lending practices, thereby operating on the credit supply side, rather than using interest rates to regulate credit demand. In future, when (if) interest rates return to more ‘normal’ levels, that might be a cause for concern – particularly if the current creeping trend towards the politicisation of monetary policy gathers pace. But this is not exactly a new problem: indeed, for a long period after 1945, the UK operated a form of macroprudential policy in the form of credit rationing. Given what we know happened to the banking system prior to 2008, I wonder why we gave it up.
Looking at the big picture, there is still a lot of debate on whether the banking system is safe enough. Sir John Vickers, who chaired the Independent Commission on Banking, does not believe it is. Earlier this year he strongly argued that the ICB’s recommendations on capital adequacy had been largely ignored and that banks do not have nearly enough capital to withstand shocks. This is a view which the Bank of England does not share. Vickers’ argument is that although holding equity capital is costly for banks, because investors expect high returns, “high returns make sense only if they compensate for risk ... which is best done by more equity, not less.” In his view, the BoE argument that leverage ratios were ten times higher before the crisis means only that banks today are too risky versus stratospherically risky prior to 2008.
But whilst the argument is sound enough, John Kay points out that efforts to measure bank leverage, as required under the Basel III legislation, represent “bogus quantification.” We cannot adequately measure bank ‘riskiness’, and efforts to put a precise number on it give us a false sense of security. In any case, it is not as if banks were not regulated previously, as anyone who tried opening a bank account even prior to the crash of 2008 can testify. It is more the case that bank regulation was previously misdirected.
This highlights that there is a trade-off between the safety and usefulness of regulation. As Kay points out, the rising numbers employed in compliance represent a heavy tax on banking activity, and banks themselves are being forced to make costs savings in other areas to ensure they can meet the regulatory challenge. Ironically, we will only know that the outlays on additional compliance are being well spent if they prevent banks from incurring the wrath of the regulator. So the less they are in the headlines, the better. But since the actions of regulators on the other side of the Atlantic appear more as a capricious attempt at extortion, it may not matter how much banks spend if they are operating on a far-from-level playing field.
It is interesting when talking to banks about their business plans to note that they are taking a highly pragmatic approach. So long as they have a clear view of what they have to do, and the timeframe under which they have to operate, they seem broadly happy with where we are heading. Indeed, there appears to be a lot more certainty today than there was a year or two ago, when bankers complained that the regulatory goalposts were being moved far more quickly than seemed necessary. It would thus appear that, in the UK at least, the field of bank regulation is beginning to mature. In its early stages, bank regulation was focused on emergency balance sheet repair and there probably was an element of on-the-hoof policy making. Today, we are able to look forward with a bit more certainty, and I am also left with a sense that banks and regulators talk to each other more than they once did.
Macroprudential policy has thus become a key element in the policy armoury. There are some concerns that it may become a substitute for monetary policy – at least in part. For example, the regulators might prevail on banks to change lending practices, thereby operating on the credit supply side, rather than using interest rates to regulate credit demand. In future, when (if) interest rates return to more ‘normal’ levels, that might be a cause for concern – particularly if the current creeping trend towards the politicisation of monetary policy gathers pace. But this is not exactly a new problem: indeed, for a long period after 1945, the UK operated a form of macroprudential policy in the form of credit rationing. Given what we know happened to the banking system prior to 2008, I wonder why we gave it up.
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