Technocrats vs Politicians Round 1...

The world of bank regulation is being torn between two very different agendas. First, the technocrats of Basel, as they struggle to put in place amendments to the comprehensive version (June 2006) that has formed the bedrock of much market and credit risk management thinking for the past few years. BIS has introduced a host of new consultative documents, subject to ratification, that promise significant increases in the levels of regulatory capital and liquidity particularly for the trading book. Initiatives like the stress var calculation, the calculation of an incremental risk capital charge for users of internal models for specific risk, counterparty credit risk capital increases, the Liquidity Coverage Ratio, the Net Stable Funding Ratio and the Leverage Ratio, all proffer band aids to weaknesses in the original accord. The danger is that the technocrats responding to real issues in the original accord lose the "high ground" and surrender the two principles that made Basel II such an innovation - capital is alligned with risk, and the better the job we do of measuring risk the lower the capital charge. Unfortunately the "band aid" approach understandable as it is, risks making an already highly complex set of regulations, conflicting, opaque and even more open to the regulatory arbitrage that brought down its predecessor - Basel I.

So not surprising therefore is the new found emphasis on the agenda of the second group of actors in this drama - the politicians. They are reacting to market and economic crisis, and selling their approaches to an angry and impatient tax paying public. Here initiatives are basically four fold. In the US, a raft of initiatives have been proposed by the Obama government, in general limiting the scope and the size of federally insured bank activities. The real challenge of all these initiatives is of course congress, where well funded lobbyists may easily derail the worst vicissitude of the proposals. The UK has taken a different approach, experimenting with macro prudential regulation an structural regulatory change, but they face two different challenges - increasing regulation yet not killing the Golden Goose of the City that sustains a sizable chunk of the UK economy. Added to which is the upcoming election which may endanger any initiative. The EU has been hamstrung by government deficits in certain member countries and has revealed just how hard it is get cross the board agreement in such national sensitive economic issues. Finally enter the G20 and the IMF, frustrated at the lack of regulatory changes a full year after the crisis, has argued for the simplest, but possibly most destructive approach of all, bank taxes based on the size of liabilities.

So whose constraints will determine the future of banking for the next ten years? I vote for the politicians - but it will further push financial innovation to the east and away from established financial centers.