Wednesday, April 27, 2011

What It Takes to Be Toughest Bank Regulator

Bloomberg ran an article in which Sweden's central bank Governor took the position that sometimes regulators have to take actions that the banks do not like.

With an attitude like that, he is a likely candidate to require banks to provide current asset and liability-level disclosure.  This requirement would greatly improve the stability of the Swedish financial system as it subjects the banks to market discipline. By making all the useful, relevant information on the banks available, market participants can exert discipline by adjusting the price and amount of their exposure based on the risk of the banks.

While adopting this requirement would be good for protecting the Swedish taxpayer, it would clearly be a requirement that the banks would not like.
Sweden must be ready to impose harsher bank rules than in the rest of Scandinavia even after its biggest lender signaled it may move its headquarters outside the Nordic country, central bank Governor Stefan Ingves said. 
“Harmony is a good thing but in the end, given that it’s the public purse that backs up the banking sector and as long as it remains like that, it’s going to be up to each individual country to choose what to do,” Ingves, 57, said in an interview in Stockholm. 
Ingves, who was one of the main architects of Sweden’s 1990s bank restructuring that led to the creation of Nordea Bank AB (NDA), said larger capital buffers will help the government safeguard taxpayer funds.
It is true by definition that increasing the amount of capital reduces the theoretical exposure of taxpayers and safeguards their funds.  However, since the beginning of the credit crisis, this has not been true in practice.

A requirement for capital to protect the taxpayers is that regulators require that losses in the banking system be absorbed first by the capital in the banking system before turning to the taxpayers.
 Nordea Chairman Bjoern Wahlroos’ suggestion this month that he may shift the bank’s headquarters to escape tougher capital rules is the latest threat from Sweden’s financial sector it will fight policy maker efforts to enforce some of the world’s strictest regulatory standards.
“We know how much a banking crisis costs and how troublesome it is to solve,” Ingves told Bloomberg today. “It’s not in the interest of society to in some sense have a race to the bottom when it comes to capital coverage.” 
That is why Sweden should adopt current asset and liability level disclosure for its financial institutions.  At very, very low cost, this disclosure works to prevent a banking crisis.

Unlike capital, this disclosure also involves a a race to the top among regulators.  After all, what country is going to allow a financial institution to move to it when the reason for moving is not to disclose the risk the financial institution is taking?

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