Industry column: ICFR - Regulatory outlook

Ahead of the G8 and G20 summits due to be held in Canada this June, a plethora of papers is spewing forth from regulators intent on meeting the ambitions and timetable set out at the last G20 meetings in Pittsburgh and London. This has left financial institutions struggling to understand and integrate the various proposals and their implications in advance of the meeting. Barbara Ridpath, CEO of the ICFR pressure group, made up of 19 financial institutions, the City of London, UK government and others, reiterates the need for cooperation

There are several problems facing authorities at this juncture. Firstly, with the crisis largely behind us, the G8 will have a more difficult time achieving consensus among countries at different stages of recovery and financial development [and it's interesting that it's this being prioritised and not the G20]. Secondly, governments must decide how to turn off extraordinary support measures and contain fiscal deficits without choking off the nascent recovery. Third, the G20, regulators and politicians alike have to navigate between 'post-crisis denial' on the part of the financial system and the popular anger that still wants to see financial institutions punished. Last of all, there will be the hard graft of trying to 'right-size' regulatory changes.

If these four challenges can be met, the efforts undertaken should reduce the chances of another major crisis in the near term, mitigate its effects and make clearer any necessary resolution mechanisms. If they cannot, the likelihood that the next crisis will occur shortly, and be far more painful is very high.

The G20 initiatives provided a clear plan for the future with emphasis on: strengthening transparency and accountability, enhancing sound regulation, promoting integrity in financial markets, reinforcing international cooperation, and reforming international financial institutions.

In spite of the G20 consensus on the need to act decisively and jointly it is becoming clear that coordination of the details is going to be difficult. Concerted action has been witnessed in the creation of the Financial Stability Board (FSB) and the extension of Basel Committee on Banking Supervision membership. National and regional initiatives have though simultaneously poured forth in a relatively unsynchronised fashion, covering everything from the FSA's new liquidity requirements; new EU institutions; to President Obama's Tobin tax-like levy to pay for bailouts. The recent Volcker proposals out of the US are also an example, and it remains to be seen whether such domestic initiatives will help or hinder attempts by the G20 and FSB to foster international cooperation regarding reform.

On top of these issues the sad politics of scapegoating has risked compounding the complexity of regulation without reducing the likelihood of future financial crises. Some of the targets for regulatory wrath are populist ones which had little to do with the genesis of the crisis - tax havens, hedge and private equity funds being obvious examples. Fissures in regulatory cooperation have been nowhere more apparent than in the treatment of bankers' bonuses. This is not surprising due to the domestic nature of tax policy and the differing political philosophies among G20 members on this subject.

Navigating the Scylla and Charybdis of the G20 agenda and domestic politics may be the most challenging aspect of 2010. With mid-term elections in the US and a general election in the UK, officials will be tempted to play to political populism. This could have dangerous repercussions for fiscal deficit control, appropriate regulatory changes and the ability to encourage the reestablishment of a vibrant financial sector.

Decisions on any of the regulatory proposals under review await the outcome of impact studies on their cumulative effect. There are two significant problems with this approach. First, it is clearly in the banks' interest to overstate the cumulative effects in the Quantitative Impact Study (QIS) exercise so as to limit the imposition of the changes. Second, there is still an inclination for regulators to respond within the existing regulatory framework, rather than to consider if the existing system is fit for purpose.

Such a prescriptive regime overweights responsibility on the supervisors. Ideally the onus of responsibility for demonstrating appropriate business practices, and solid capital and liquidity foundations should be on the banks and their shareholders. The drafters succumb to the temptation to address the complexity of banking with ever more complex formulas for the calculation of risk, when I believe simplification and principles-based regulation is what is needed to address the current opacity of regulation.

Last of all remains the unfinished agenda including cross-border crisis resolution and 'living wills', which must now be translated into harmonisation of crisis procedures and global tools, just as macro-prudential regulation needs to move from concept to credible implementation. Another subject yet to be tackled is whether the home country should cover the entire cost of bank rescues, regardless of the breadth and scope of those operations around the world.

The real work now begins: translating good intentions into regulation that strikes a balance between improving systemic stability without completely debilitating the financial institutions concerned and stifling competition and innovation. Should we overburden the G20 with our expectations, they will be doomed to failure. All parties: legislators, regulators, financial institutions and investors, need to propose viable solutions that address the problems without destroying the capacity to finance the economy.

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