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Wednesday, 17 December 2014

Can the tightening of financial regulation be made consistent with a resumption in sustainable growth?

Alexandra Zeitz (Global Economic Governance Programme, University of Oxford)

A recurring theme in PEFM’s seminars over the last term has been the notion that regulatory responses to the financial crisis of 2008 have not been tied into a coherent, overarching framework. So too in Cyrus Ardalan’s presentation on December 1, when the Barclay's Vice Chairman and Head for UK and EU Public Policy and Government Relations gave a vast and informative overview of financial regulation since the crisis, analyzing the consequences of this regulation for sustainable growth.

In the absence of a coherent framework that adequately emphasizes sustainable growth, Ardalan suggested, regulation could have adverse consequences. He argued that new regulation was urgently needed in the aftermath of a crisis that revealed widespread weaknesses, especially in flawed risk models and exceptionally high leverage. However, he also contended that the spate of post-crisis regulation, particularly capitalization and liquidity requirements, placed burdens on banks that make it increasingly difficult for them to play their critically important inter-mediation role.

As the costs increase with regulation, so Ardalan believed, banks will withdraw from both inter-mediation and risk management; there are high capital requirements associated with exposure to derivative markets. Banks have already dramatically reduced their holdings of securities. Several commentators have argued that a withdrawal of banks need not be detrimental, and suggested that Europe, in particular, is over banked. Especially by comparison to the US, European capital markets remain small, and these commentators hope that capital markets could take over the inter-mediating role as banks recede. The proposed EU capital markets union championed by European Commission President Jean-Claude Juncker is intended, largely, to address these types of concerns.

Those enthusiastic about the benefits of the non-banking sector should be sensitive, however, to the close connections between banks and the non-banking sector. Capital markets are a vital source of growth-boosting equity, but they are also dependent on banks. Ardalan argued that liquidity requirements for banks will have knock-on effects in capital markets that have so far been insufficiently considered in regulation. Without healthy banking systems, capital markets cannot be a panacea for growth.

The crisis was, in the eyes of the public at least, as much about bankers’ behaviour as about structural flaws. Banks took these concerns seriously, and Ardalan provided examples of Barclay's initiatives intended to improve corporate culture, including defining for the first time a set of corporate values. Yet, what more must banks do to eliminate irresponsible behaviour? The sector has been beset by scandals in the aftermath of the financial crisis that show ‘culture’ problems have yet to be resolved. Discussion after the presentation grappled with the question of individual versus institutional responsibility: regulators have imposed fines on banks in the aftermath of scandals in the belief that threats of fines will incentivize stricter managerial oversight. Banks would prefer to see consequences also resting with the individuals responsible.

As the financial regulatory regime undergoes further adjustments in the coming months and years (e.g. in the EU’s banking union), the objectives of stability and growth will have to be balanced. Much political initiative will be needed, particularly at the international level, to weave regulatory fragments into a coherent and internally consistent framework.

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