When regulators become defiant of… regulation

After years of regulatory boom, some politicians, and regulators, seem to be – slowly – waking up. I have already described how UK’s Vince Cable seemed to now partially understand that regulation doesn’t make it easy for banks to lend to small and medium-sized businesses, and how Andrew Bailey, from the Bank of England’s Prudential Regulation Authority, complained about the lack of regulatory coordination across country:

I am trying to build capital in firms, and it is draining out down the other side.

Well, Bailey is at it again. Reuters summarized Bailey’s latest speech as:

The over-zealous application of anti-money laundering rules is hampering British banks abroad and cutting off poorer countries from global financial markets, a top Bank of England regulator said on Tuesday.

He said:

We have no sympathy with money laundering, but we are facing a frankly serious international coordination problem. […] We are seeing clear evidence … of parts of the world and activities that are being cut off from the mainstream banking system. […] It cannot be a good thing for the development of the world economy and the support of emerging countries … that we get into that situation. […] I have to spend a large part of my time dealing with the issues that come up in this field … because some of the consequences of the actions taken are potentially existential.

I find it quite ironic to see a regulator disapproving ‘over-zealous’ regulation. Another regulator, Jon Cunliffe, Deputy Governor of the Bank of England, declared that:

Liquidity and market making does seem to have been reduced. […] We’re not sure how much of it is the result of regulatory action, and how much of it is do with the change in business model for the institutions.

While he believes that some of the pre-crisis liquidity was ‘illusory’, his statement clearly indicates that he knows that regulation might not have had only positive effects. (Four days after I spoke about regulatory effects on market liquidity, Fitch published a press release arguing the exact same thing. I still have to write that post…)

Unfortunately, not all regulators are waking up. Reuters reported that David Rule, also from the BoE, said that:

banks had responded to regulatory incentives and increased their focus on the real economy, rather than financial market trading for its own sake.

Really? With business lending stuck at the bottom and mortgage lending (a very productive form a lending to the real economy) booming again? I see.

Andreas Dombret, of the Bundesbank, recently declared in a relatively reasonable speech* that:

But are we really overregulating? If we look at the benefits to society of a stable banking system and the social costs of a banking crisis, I believe the costs of regulation are justifiable.

Clearly he and Bailey should have a proper conversation…

Others, like Andrea Enria, Chairman of the European Banking Authority, which recently ran the European stress tests, warned that

The story is not over, even for the banks who passed it

I am unsure what the goal of that sort of threatening comment is, but I don’t see how this can reintroduce confidence in the European banking system. It certainly will push bankers to consolidate their balance sheet further rather than to start lending more. Let’s not forget that the EBA and ECB tests have the power to create a panic and destabilise markets when nothing would have occurred. Too soft and nobody would trust the tests. Too tough and a panic might set in (imagine the headlines: “Half of European banks at risk of failure!”). Another risk is that investors and commentators stop relying on their own judgment and analysis and start relying too much on regulators’ assessment. This would be extremely dangerous. Yet this already happens to an extent. Perhaps, as more and more regulators start waking up to the potentially harmful side effects of regulatory measures, they will back off and let the market play its role?

* While the speech is overall reasonable, Dombret still comes up with usual myths such as

Yet a leverage ratio would also create the wrong incentives. If banks had to hold the same percentage of capital against all assets, any institution wanting to maximise its profits would probably invest in high-risk assets, as they produce particularly high returns.

This is not correct.

Funnily, he also kind of admitted that regulators did not always understand how banking works, as I’ve been arguing a few times recently:

Do supervisors have to be the “better bankers”? No, absolutely not. Business decisions must be left to those being paid to make them. However, supervisors have to know – and understand – how banking works. Against this background, I personally would very much welcome an increase in the migration of staff between the banking industry and the supervisory agencies.

Still, many regulators influence business decisions…