After lowering interest rates, unleashing fiscal stimulus packages and protecting banks deemed ‘too large to fail’, the next item on the post-crisis policy agenda will be to address some fundamental questions about the future of banking itself. The heads of government of the G-20 leading economies agreed at their April summit to take action to build a stronger, more globally consistent, supervisory and regulatory framework for the future financial sector.
Strengthened regulation and supervision, they said, “must promote propriety, integrity and transparency; guard against risk across the financial system; dampen rather than amplify the financial and economic cycle; reduce reliance on inappropriately risky sources of financing; and discourage excessive risk taking”.
If the consensus holds and their action plan is carried through, banks may emerge from rehab profoundly altered in terms of their character, autonomy — and profitability.
Compiled by Chris Owen
10 steps out of the abyss
1| Capital, capital, capital
Force banks to hold more capital and increase their holdings of liquid assets and cash, thereby decreasing risk and leverage.
2| Rainy-day savings
Otherwise known as the Economic Cycle Reserve — regulation that forces banks to build up buffers of resources in good times to future proof against bad times.
3| Corral the hedgies
Extend all regulations to all important financial institutions, including hedge funds, that have so far evaded scrutiny.
4| See clearly
Clamp down on the off-balance-sheet vehicles. The growth over two decades of structured investment vehicles (SIVs) meant that many banks were involved in transactions worth billions of pounds that did not show up on their balance sheets. This was a problem because of the mismatch of liabilities.
5| Rein in bonuses
The G-20 agreed that firms’ compensation policies will be included in an overall assessment of their soundness. Future compensation is likely to be judged over a longer term, skewed towards stock rather than cash, and subject to “claw-back” in the event that a product fails later.
6| Regulate tax havens
The G-20 called for an end to bank secrecy “to protect our public finances and financial systems” and threatened sanctions against jurisdictions identified by the OECD as uncooperative. These moves could have a serious impact on the profitability of international banks.
7| Standardise the accounting rules
The G-20 leaders agreed that it would be highly desirable to move towards a single set of high quality global accounting standards.
8| Create a pan-European regulatory body
Lord Turner, chairman of the UK Financial Services Authority, now supports the creation of a pan-European regulatory body, a move the FSA and the City of London had previously opposed, as the only way to save the European market for financial services. It would craft pan-EU rules, oversee regulatory colleges in the region and work alongside central banks on macro-prudential issues. “We’ve got to think about how to run a single market in retail banking without a European federal government,” says Turner.
9| Sort out the credit rating agencies
All credit rating agencies whose ratings are used for regulatory purposes should be subject to regulation and registration. In particular, rating agencies should differentiate ratings for structured products and provide full disclosure of their ratings track record and the information and assumptions that underpin the ratings process.
10| Bring back the Glass-Steagall Act
Politicians on both sides of the Atlantic have been pressing for banks to be forced into finding a means of ring-fencing or splitting off their riskier investment banking businesses along the lines of the US Glass-Steagall Act, which was controversially repealed in 1999. Such a move would trigger shockwaves across the City and Wall Street, but is at present considered unlikely because the G20 appears to favour beefing up bank regulation rather than forcing them into breaking up their businesses.
Countdown to Disaster
1971 — US President Richard Nixon’s abandonment of the gold peg devalued the US dollar, in effect causing the break down of the Bretton Woods system by which exchange rates were fixed.
1986 — Margaret Thatcher’s “Big Bang” of deregulation in the City abolished fixed commissions and turned the partners of City firms into salaried employees, clearing the way for bonus-driven risk-taking.
1997 — UK Chancellor Gordon Brown took bank supervision duties away from the Bank of England, replacing it with his “light touch” regulation via the Financial Services Authority, implicated now for failing to regulate the banks
1999 — US President Bill Clinton signed the Financial Services Modernization Act. This, in effect, deleted the prohibition on commercial banks owning investment banks, and vice versa, which had been brought in under the 1933 Glass-Steagall Act in the wake of the 1929 Wall Street Crash. Citigroup, JPMorgan Chase and other large US banks immediately began to offer mortgage-backed securities and collateralised debt obligations to investors around the world.
2000 — President Bill Clinton signed the Commodity Futures Modernization Act into law. The effect was to allow certain financial products — such as the now notorious Credit Default Swaps (CDS) — to go largely unregulated by the SEC or the Commodity Futures Trading Commission. By the end of 2007, the CDS market had a notional value of $45tn.
2004 — A SEC decision related to the net capital rule allowed US investment banks to issue substantially more debt, which was used to buy sub-prime mortgage-related debt.
2008 — Lehman Brothers is allowed to fail in September under the weight of its outstanding debts and obligations, some of them related to sub-prime mortgage securities.
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