“It was approved by regulators”

If ever you needed a single sentence to symbolically prove that today’s financial markets aren’t free, there you go.

You can’t possibly imagine the countless times I’ve heard this, both as part of my various jobs* or in the financial press. The process is pretty much always the following:

1. Banking executives privately or publicly  denounce regulators as incompetent and/or not understanding much about actual banking practice
2. Investors/shareholders/journalists/analysts/other bankers question those executives about a recent, often suspect, change in their internal methodology that allows them to book higher profits/ROE
3. Banking executives seriously justify their decision with: “It was approved by regulators”

Let’s clarify something: not all bankers are critical of regulators, and not all bankers are so inconsistent either. Most bankers thrive to do their job correctly and honestly, and believe that their decisions are appropriate and for the long-term benefit of both clients and shareholders.

Nonetheless, regulators have become some bankers’ strongest ally and the easiest justification to bypass market discipline. When shareholders are worried about a new, apparently risky, change in internal models, underwriting criteria or anything else, bankers don’t have to look very far to find a good excuse anymore. Regulators inadvertently become bankers’ best friends.

A typical illustration of that story occurred about a year ago, when Morgan Stanley changed its internal Value-at-Risk-based market risk model, which all of a sudden made its trading book look less risky than it would have been under the previous version of that same model. Many finance professionals and investors were critical of the move. How did Morgan Stanley’s CFO dismiss analysts’ questions?

It’s been approved by regulators.

While she may have been honestly thinking that the new model was better or more appropriate, the use of this argument is unfortunate. This is now the best – and the worst – defence bankers have against crucial free markets’ scrutiny.

*no, no names again, and none of my previous or current firms