2.11 If that broad diagnosis is correct, then much of the activity in regulation looks to be irrelevant, at best, and falsely reassuring at worst.
2.12 The proposed reforms to regulatory structure in a number of countries are a case in point. As David Green3 points out in his chapter, we can draw no very obvious conclusions from the relative performance of different regulatory systems in the crisis. The regulatory structures of the United Kingdom and of the United States could hardly be more different. The UK system was highly integrated, the US system was highly compartmentalized, yet both performed rather poorly, at least in the build up to the crisis. If we look also at the countries, which seem to perform relatively well, like Australia, Canada, and perhaps Spain, no clear pattern emerges either. There is no convenient correlation between success and any particular structure, nor is it possible to say that central banks as regulators have done systematically better or worse than non-central banks. The Bank of Spain has been praised by those who support a strong role for the central bank in regulation for its introduction of dynamic provisioning (though less so as the problems of the Spanish banking sector have become better understood), but in both Australia and Canada the central banks have no direct involvement in banking supervision, and the non-central bank regulators have done very well.
2.13 There are a few tentative conclusions one might draw, however. The complex interactions between different types of financial institutions, which were revealed during the crisis, are a further argument for some form of regulatory integration. The case of AIG, for example, an insurance company that came to grief through its dealings in securities markets with banks, vividly illustrates the need to take an overview of market trends to understand emerging systemic risk. Specific problems of underlap and overlap have been identified from place to place. That is particularly true in the United States, where the regulatory system is surely still over-complex.
2.14 In Europe, the Icelandic banking crisis revealed a major flaw in the operation of the single financial market. Icelandic banks regulated by their own domestic authorities were able, under the provisions of the single financial market, to take deposits in the Netherlands and United Kingdom, without oversight from the host regulators. Yet the domestic Icelandic authorities were unable to provide the backing needed for their banks when massive losses, largely in property-related lending, were exposed. So it has been necessary to revisit the home-host regulatory relationship and to explore other options for the regulation of pan-European institutions
(p. 52) 2.15 In the United Kingdom, the main conclusions seem to be that there were poor communications and somewhat dysfunctional relationships between the Bank of England and the FSA, and a Treasury which seemed not to be capable of knocking heads together within the context of the tripartite arrangements. Whether that justifies a major reworking of the institutional structure is less clear.
2.16 At global level the conclusion reached by the G20 is that the central bodies were too weak, and had the wrong membership. Arguably, the link between the membership structure of the Basel Committee and the FSF (as it then was) and the causes of the crisis is a little loose, but it is not negligible, and the argument for shifting away from the G7 to a broader grouping has been powerful for some time. While central banks and regulators watched the build up of global imbalances, the major firms in which they came together did not include any representatives of many of the biggest surplus countries, notably China. So some of these reforms, while unlikely to prevent future problems, may make sense in their own terms, and should perhaps be considered under the general heading of: ‘it is important never to waste a good crisis’.
2.17 But while recognizing that the crisis has stimulated sensible changes which should have been made some time ago, even if a path cannot be easily tracked back from them to the flaws which led to our problems, it surely vital to ask whether we think that the reforms so far have made the financial world a safer place, and whether they amount to an effective response to the problems identified?
2.18 Against that background, the initial global response was quite positive. The switch to the G20 was probably inevitable. Arguably, the G20 is too large a group, just as the G7 was too small. It might have been preferable to construct a group for financial oversight comprised of countries with very large international markets in their jurisdiction. That would point to the membership of Singapore, for example, but not Argentina. However, the time for that argument has now passed. There are very few examples of countries being relegated from positions of influence in international groupings once they have been admitted. So the G20 must be made to work.
2.19 I am also in favour of the change from the FSF to the FSB. David Green and I recommended a change along those lines in our book on global financial regulation.4 Of course, it may be argued that renaming a body does not, in itself, give it greater powers. But the fact that the G20 ministers now look to the FSB to coordinate regulatory changes is positive. The Cannes summit in November 2011 agreed that the FSB needed a legal personality and stronger staff support. That is also positive. So there is now a much more effective accountability mechanism for groups like the Basel Committee and IOSCO. It will not to be possible in future for Basel to (p. 53) spend a decade producing a capital accord, as it did in developing Basel II. Indeed, the outline of a new Basel III has been produced very rapidly, partly because the FSB demanded rapid progress. The FSB has set out a broadly sensible agenda, focusing first and foremost on reforms to the capital regime, which do look to be essential to improve the stability of the system in the longer term.
2.20 The new capital accord is absolutely central to the reform programme. It is clear that banks need more capital than they held in the past, especially in their trading books, and they need that capital to be of better quality. In other words, they need a larger proportion of common equity capital in the total. Broadly, the banks themselves accept that conclusion, but they are currently concerned that the aggregate of the changes under Basel III could amount to overkill. It may be that regulators are beginning to demand more capital from banks than they could reasonably take on, and to do so in a way which effectively will increase the cost of credit to borrowers and, in turn, slow down the recovery.
2.21 The regulators are well aware of these concerns, and of the risk of tightening their requirements at a time when capital is scarce and credit is in short supply. Though the regulators are still talking tough, I suspect they will be prepared to envisage longer phasing in of new requirements over time. There is a need, too, for some rationalization of the various different ‘buffers’ in Basel III.
2.22 The work on cross-border resolution, which the Lehman Brothers collapse showed to be especially important, is moving more slowly. The legal complexities of cross-border bankruptcies are immense. It may be that progress made already towards establishing domestic resolution authorities will be helpful, but although the FSB has now made some constructive proposals there is a distance to go before we can say that we have a global resolution mechanism which matches the interconnectedness of markets. Without that, there will certainly be a tendency for regulators to seek to ring-fence capital within their jurisdictions to protect the domestic counterparties of a failing firm.