Tuesday, December 4, 2012

WSJ's Francesco Guerrera calls for Simpler Remedies for Banks

The Wall Street Journal's Francesco Guerrera became the latest to call for ending regulatory complexity and instead implementing simpler solutions that improve the safety and soundness of the financial system.

The reason for ending the race towards ever greater levels of regulatory complexity is the current financial crisis showed that the combination of complex rules/regulations and regulatory oversight fails as a substitute for transparency and market discipline.

Since transparency and market discipline are superior, the focus should be on bringing transparency to all the opaque corners of the financial system so that market discipline can works its magic.

For example, by bringing transparency to banks, we get a culture change as sunlight is the best disinfectant for bad banker behavior.

Or, as another senior watchdog told me, "We have enabled banks to get bigger in the crisis but we haven't devised a way not to bail them out in case of failure." If the statement sounds scary, that is because it is. 
Part of the reason for these shortcomings is that regulators and banks are drowning in complexity. As lenders have become more and more complicated, the authorities have responded in kind.
A response that protects the regulators' information monopoly and market participants' dependence on the regulators.

Remember, if banks have to provide ultra transparency and disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details, market participants can independently assess the risk of each bank themselves.

This dramatically decreases the influence of the regulators in the financial system.
The seminal Glass-Steagall Act of 1933, which forced banks to split their securities businesses from consumer units, was 37 pages long. Dodd-Frank is more than 20 times that, with some 30,000 pages of associated regulations expected on top. 
"Dodd-Frank makes Glass-Steagall look like throat-clearing," quipped Andrew Haldane, a top Bank of England regulator, at the Federal Reserve's Jackson Hole symposium in August. 
The arms race of complexity between banks and their guardians is having the same result as its Cold War equivalent: stalemate.
Stalemate that benefits the banks.  The banks continue to extract money from the real economy that they would not otherwise receive if there were transparency.
Regulators are struggling to catch up with banks' increasingly arcane businesses, while lenders and investors bemoan the paralysis created by the proliferation of rules. 
If the final goal is to make banks smaller and less risky, one solution would be for regulators to take a step back, limiting themselves to rules that are broad and easy to understand, as Glass-Steagall was. Mr. Haldane, among others, has made a strong case for simplicity.
Banks have increasingly arcane businesses as they are focusing on the opaque areas of the financial system where they can engage in bad behavior behind the veil of opacity.

Both the behavior and these businesses would effectively go away if there were transparency.
But broad-brush regulation can succeed only if two conditions exist. 
First, banks would have to shed unprofitable businesses much faster than they have.
And second, regulators would need to rely less on the rule book and more on their knowledge of individual institutions.
Rules that are constantly fine-tuned in a vain attempt to keep up with the industry would be replaced by more general rules policed by watchdogs with their ears to the ground.
Knowledge of individual institutions that regulators can obtain by harnessing the market's ability to assess each institution.

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