Felix Salmon

The regulatory consensus

By Felix Salmon
January 30, 2010

The big meeting this morning between global bankers and regulators is exactly the meeting I was hoping would happen. A large group of bold-face names such as Larry Summers, Brian Moynihan, Alistair Darling, and Mario Draghi, meeting behind closed doors, reportedly came to the obvious yet necessary conclusion that, in the words of Darling, “we are agreed that whatever we do, it needs to be universal. You’re dealing with a global banking system. You need a common approach across the world”. And some good news is slowly emerging: already regulators and banks seem to be coalescing around the need to create a wind-down fund which would allow the orderly resolution of insolvent banks.

It’s easy to say such things, of course: the difficulty is in the international coordination needed to enact them. At the panel on financial regulatory reform today, everybody was at pains to say that every country is different and therefore needs its own custom-built regulatory regime: all we’re really talking about here is something called “regulatory consistency”, which, if the stars align correctly, might hopefully cut off most of the opportunities for banks to engage in regulatory arbitrage.

Yeah, me neither.

Still, a few interesting ideas did emerge. I particularly like the idea that no banks should be allowed to have branches in foreign countries: if you want to set up abroad, you need to have fully-fledged subsidiaries in each company, regulated domestically as if they were domestic banks.

This would have a lot of good consequences. For one thing, it would prevent problems such as those we’ve seen in Switzerland, Iceland, and the UK, where bank assets are enormous multiples of GDP, and consequently bank bailouts can be fiscally disastrous. It’s worth noting that Kaupthing had a subsidiary in Germany, while Landsbanki had branches in the UK; the result is that now the Icelandic government owes enormous sums of money to the UK, and nothing to Germany.

There’s also the Mexico problem, which is true in many other emerging markets as well: the Mexican banking sector is dominated by three foreign banks, all of which are too big to fail in their home country. Should their Mexican subsidiaries be forced to have high capital ratios and low leverage just by dint of the size of the parent company? What will that mean for the availability of credit in Mexico? Perhaps if those subsidiaries were truly answerable to the Mexican regulatory authorities, that might help matters. And it would also help fix the Walmex problem: Walmart has banking operations in Mexico, but it isn’t allowed to do that in the US, and isn’t regulated as a bank in the US. Which means that there really isn’t an ultimate bank regulator for Walmart’s Mexican banking subsidiary.

The star of the panel, however, was Davide Serra, the principal of a UK hedge fund named Algebris. He’s caused quite a splash at Davos in 2010, and seems to have built some very strong connections with high-level policymakers in the official sector. He said that if you have 2,800 people at the Financial Services Agency in the UK trying to regulate 1 million better-paid financial-sector employees, that’s “like trying to regulate a Ferrari with a skateboard”. And he also said, quite rightly, that it’s possible to focus far too much on capital ratios: after all, insolvent banks can continue more or less indefinitely, while a bank facing a liquidity crunch can collapse within a day.

Serra noted that the US, with its six different bank regulators, was “a disaster”, and that the UK, with its three regulators, wasn’t much better; the countries which navigated the crisis most effectively had only one regulator. And he had a provocative idea about who that one regulator should be, saying that it should be given, every five years, to the most admired and successful bank CEO of the time. It’s an idea which won’t ever happen, but it does make a certain amount of counterintuitive sense when you start to think about it.

Ultimately, I doubt that the World Economic Forum has really made any difference to the global regulatory agenda, or to the US decision to chart its own course with things like the Volcker Rule rather than try to engineer international consensus. But if it has made a difference, I think it’s done so by forcing the banks to face reality and start making constructive noises about helping to build a new global regulatory regime, rather than simply fighting any proposed rules which might crimp their risk-taking. A world where Barney Frank and Gary Cohn can agree is a world with some hope left in it.

4 comments so far | RSS Comments RSS

If it’s fairly certain that a financial institution is solvent, it becomes comparatively easy to say “you can borrow at 18% whenever you need to” — it becomes easier politically to say you can borrow from the fed, but it also becomes easier for a smaller bank to borrow from, say, JP Morgan or Berkshire Hathaway, at least where “smaller” means small enough that a single entity can provide all the liquidity the bank needs without significantly impairing the larger entity. (That same principle applied when “smaller” is in comparison to the Fed, I suppose, which gets us back to the “too big to bail out” problem.)

Incidentally, I was — literally — hiking the Appalachian Trail when Bear went down, and have recently been reading all the details that weren’t public at the time, anyway, and they were operating on something like $70B of overnight funding, and asked JPM initially for a loan on the order of $40B. Well, I’m not sure Bear was solvent, although it seems more plausible to me than it did two months ago, but that’s an awfully big liquidity burden even for JPM or BRK. If it had been a third that size, and clearly solvent, Buffett would have loved to play loan shark; he’s no longer worried that he needs the rest of the market to get rational, at least not anytime soon.

Posted by dWj | Report as abusive

King urges division of global bank empires

Mervyn King, the Governor of the Bank of England, told MPs today that the best way to reform multinational banks was to force them to divide into national subsidiaries that can be shut down in the event of a future failure.

http://business.timesonline.co.uk/tol/bu siness/economics/article7002962.ece

I’m surprised that this subject has not been commented on before. It’s a very good idea.

Posted by polit2k | Report as abusive

Volcker to spell out future of banks

The BBC has obtained a recent article by Mr Volcker for a specialist magazine, OMFIF (Official Monetary and Financial Institutions Forum).

In it, Mr Volcker made it clear that he wants a complete separation of commercial banks from the financial markets.
“We simply cannot afford further financial market breakdowns,” said Mr Volcker’s article.
“I favour a separation of commercial banking activities that are essential to the functioning of our financial system from more speculative trading-oriented capital markets activities that are not.
“To lower the risk and vulnerability of commercial banks, I favour prohibiting their ownership or sponsorship of hedge funds, private equity funds, and large-scale purely proprietary trading activities in securities, derivatives or commodity markets.
“These measures would directly eliminate potential areas of risk, reduce conflicts of interest and focus management attention on the core functions of banking.”

http://news.bbc.co.uk/2/hi/business/8486 091.stm

This seems to be very much at odds with Tim Geithner’s view, let alone continental european banks.

Posted by polit2k | Report as abusive

“And he had a provocative idea about who that one regulator should be, saying that it should be given, every five years, to the most admired and successful bank CEO of the time.”
may I remind all here that Ken Lewis, then head of Bank of America, won “Banker of the Year” when Bank of America bought Merrill Lynch, only to have it revealed after the merger closed that Merrill Lynch had in fact lost twice as much money as it had disclosed at the time of the Bank of America’s shareholders’ vote in favor of the merger. Eventually even the board of Bank of America forced Lewis out.
The most succcessful and admired bank CEO — like the most successful and admired CEO of, say, energy companies, such as Enron? — may only be the biggest empire-builder.

Posted by Eastvillagechic | Report as abusive

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