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Commentary: Regulators' Recommendations Are an Exercise in Fantasy
Traders Magazine Online News, October 26, 2009
On Oct. 21, the Senior Supervisors Group delivered its recommendations, entitled "Risk Management Lessons from the Global Banking Crisis of 2008," to the Financial Stability Board.
The FSB was formed by the G-20 group of nations to recommend regulations that can be adopted by all G-20 members with a view to avoiding the next financial crisis. Each of the G-20 members is concerned that if their regulations are perceived as too strict, financial services firms will relocate to more business friendly jurisdictions, a behavior popularly derided as "regulatory arbitrage." So, the idea is that the FSB will propose regulations that everyone will agree to adopt--a principle known as "convergence"--thereby removing the economic incentive to engage in regulatory arbitrage.
The SSG is composed of regulators from seven nations: Canada, France, Germany, Japan, Switzerland, the United Kingdom and the United States. While all other nations sent representatives from one regulatory agency, the U.S. sent representatives from four: The Board of Governors of the Federal Reserve System, the Federal Reserve Bank of New York, the Office of the Comptroller of the Currency and the Securities and Exchange Commission. The U.K. sent representatives from the Financial Services Authority, which is roughly the SEC's counterpart in Britain, but not from the Bank of England, which has responsibilities equivalent to the Fed. The U.S. Commodity Futures Trading Commission was not represented, although most of the regulators that supervise futures markets in other nations were represented.
Most remarkable in its absence, neither the College of European Securities Regulators, which advises the European Commission, nor the European Central Bank, sent representatives to the SSG. As a result, the European Union, which is the largest single entity in the G-20, was not represented on the SSG.
The SSG's report describes the efforts taken by banks and broker-dealers since the crisis ensued to firm up their risk management functions in 10 major areas. We have witnessed several catastrophic banking failures at global banking institutions, and all major U.S. banking institutions in the United States required life support from the U.S. taxpayer to survive. The U.S. experience was more or less repeated throughout the G-20. It is vast understatement to say that the crisis revealed widespread deficiencies in risk management.
So, in light of this near-death experience, what has the patient done? Quit smoking? Gone back on the blood pressure medication? Given up high cholesterol meals? Resumed the fitness program? The answer from the SSG is, "not much."
To be fair, the banks claim that much has been done. They have appointed some people to their boards with financial expertise and made efforts to train the others. Risk management departments have received more resources, and risk management officers now sit on management committees. Risk management officers now formally report to a Chief Risk Officer at most firms, rather than to a business line executive. Firms report spending a lot more attention to risk, and to that end, have taken steps to improve internal control of liquidity, which should enable them to better withstand adverse events.
On a further positive note, the collapse of Lehman Brothers, followed by AIG, vividly demonstrated the exposure of our global banking system to counterparty risk. The firms that were able to react quickly to these events fared much better. As a result, most firms reported substantial investments in counterparty risk systems.
