Global Financial Regulation – Time for Long-Term Thinking

A few weeks ago I spoke on a panel at the St. Petersburg International Economic Forum, with leaders from the worlds of finance and government, discussing smarter reforms to global financial regulation, and the challenges that exist in trying to develop a consistent regulatory framework.

The global financial crisis (GFC) in 2008 reminded us that the world’s financial markets are intricately interconnected. What may appear to be a domestic issue (U.S. subprime mortgages), can have dramatic global consequences. Since 2008 politicians and regulators have been searching for a regulatory solution to prevent another 2008 style GFC.

The approach of regulators has been primarily to focus on increasing capital in the banking system, this has been the right thing to do, not least because it has been a fundamental step in restoring public confidence. That said, it is a an expensive tool, and the next GFC (which is hopefully many years away) will not be the same as the last, it will have different catalysts and consequences, and developing regulation to rectify the wrongs of the last crisis may not protect us from the next. The focus on bank capital is a short term solution, this and an increase in reactive regulation is having a negative impact on business. The lack of available funding is inhibiting business’s ability to fund growth, particularly SMEs and those in emerging markets, without funds companies are not able to invest in new products, new services, new systems and process which would spur growth and employment.

The challenge for business of getting up-to-speed with new regulation could be better understood by regulators who should try to keep in mind how the private sector will implement and respond to regulation. We only need to look at how the squeeze on funding has increased the shadow banking sector – which is largely unregulated, to get an idea of the potential consequences of not thinking ahead about how markets will respond to regulation. Essentially we need more smarter regulation, to get this we need to be prepared to think more broadly about how regulation is developed and be open minded to alternatives.

When developing new regulations, regulators should ask themselves if regulation is really needed, or is there another way to achieve the same outcome. In many cases, strong prudential supervision would do as a good a job, if not a better job than rule based regulations. Each financial crisis brings about the establishment of new supervisory bodies, whether the Securities and Exchange Commission (US) post Great Depression, or the Financial Stability Board (post GFC).

Business deals with global regulation by looking across all the countries in which they operate and by developing a globally consistent approach. If business can approach regulation in a truly global way in an effort to be compliant yet cost efficient, is it possible that regulators could take a similar approach?

Despite often talking global, regulators tend to still act locally or in their own national interests, without consideration of other regulations. There are numerous examples of this regulatory ‘think global act local’ approach. National regulators are interested in ring fencing ‘their’ parts of large financial institutions – this has a major affect on capital allocation creating challenges for a bank’s business model. It can create local balance sheet constraints – where how much a bank can lend to a business is limited (this happens when that entity is based in a country where the bank needs to maintain a higher capital ratio). If the bank were able to control more of its capital allocation, it might decide that a credit surplus in one country could be used to increase lending in another – helping to promote growth. There is also the case of extraterritorial regulations, like FATCA, which while serving the purpose of one country, may conflict with regulations in another or impose significant global costs – there is need for a greater harmony of global regulations.

Regulation could be more flexible, which might negate the need for the regular updates and new regulations. There is a tension in the global economy between the need for growth and the need for more (but smarter) regulation. The Basel requirements have had an impact the availably of credit – a key driver of growth. Could for example the capital requirement ratios of Basel be a floating percentage, when the economy is contracting the ratio goes up, when economies are turning towards growth – as there are now (albeit slowly) the ratio is reduced thus allowing more capital to flow into the market.

I also think the wider financial community has a role to play in improving regulation. There are many intermediaries, (not least auditors) operating in the financial services sector that have a great deal of knowledge and expertise which could contribute towards smarter regulation. Being involved in the financial services sector is a responsibility that we take incredibly seriously and I know that trust is at the heart of this debate. It is hugely important that everyone involved in the financial markets does everything possible to rebuild and maintain trust in our financial systems and oversight of this should be provided by the many supervisory bodies which exist already.

What I have taken away from the discussion I had in St. Petersburg and many others over the last few years, is that regulation can be smarter and more effective. We are at a critical juncture in the global debate on the regulation of the world’s financial sector, and I believe it is important as part of this debate that we look at all the options and make use of all available talents and insights in finding solutions. All too often regulation is focussed on the negative, that is to say it tells business what it can't do, how about some longer term thinking, which looks at developing regulations which are positive and tell business what they can do.

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