The idea of a “Europe without banks” became popular after the financial crisis, when bankers were demonised and punitive regulations proposed. Six years on, the repercussions still resonate deeply, as I found at the recent Alpbach Financial Markets Symposium, where the high Austrian location gives an added sense of perspective to Europe’s issues.
Of course, flawed culture and poor oversight in some financial institutions contributed to the misbehaviour of individuals. It is also no surprise that the crisis led to massive and much-needed changes in regulation – including higher capital and liquidity requirements, more effective governance, and better supervision. But it doesn’t then follow that every single aspect of more regulation is an improvement. As in life generally, there are trade-offs. Higher capital requirements mean a higher cost or reduced availability to end-users of regulated institutions – as has happened when rules to reduce risky lending have resulted in a squeeze on funding for SMEs.
This trend contributes to businesses moving to institutions subject to less onerous regulations, the growth of what is misleadingly called “shadow banking”. But will lenders and borrowers be better served by non-banks? And can the “shadow banking” system, by definition less susceptible to government and regulatory intervention, be a threat to financial stability? Some fear this – in China in particular.
Of course, more choice for end-users is a good thing, and the movement of some activity outside the banking sector will be a positive development. But it also poses risks to those inexpert borrowers and lenders who have no protection. If the unregulated sector were to become very large, it could even pose a threat to financial stability. Again.
The discussions at Alpbach centred on the complexity of new regulations, as well as their volume. The significant extra regulatory requirements for banks, in particular regarding capital and liquidity, are now nearly all in place – but different countries have taken different approaches, adding to complexity. The “Vickers split” is the chosen British solution to banks’ structural issues, but this may not be compatible with whatever emerges from the EU.
Banks themselves add to this complexity through their desire for “clarity” in regulation, which in regulatory practice often ends up meaning length and complexity. Compliance costs are now huge, and the prospect of any reduction in regulation, however well it could be justified, is tiny.
There are no simple answers to these issues, but there should be common agreement that regulatory policy needs to take a more holistic view than simply concentrating on the soundness of banks. Douglas Flint, chairman of HSBC, recently spoke of “an observable and growing danger of disproportionate risk aversion creeping into decision-making in our businesses”. His call for greater realism from regulatory bodies over their expectations of banks will be crucial if we are to avoid creating a new crisis out of the measures which were actually designed to prevent a recurrence of the last one.