tag:theconversation.com,2011:/au/topics/northern-rock-4774/articlesNorthern Rock – The Conversation2018-04-29T09:00:02Ztag:theconversation.com,2011:article/955582018-04-29T09:00:02Z2018-04-29T09:00:02ZSouth Africa joins the club that regulates financial markets through ‘Twin Peaks’<figure><img src="https://images.theconversation.com/files/216457/original/file-20180426-175038-1jxpor4.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">shutterstock</span> </figcaption></figure><p>South Africa is preparing the ground to migrate to a new way of regulating its banks and <a href="http://www.treasury.gov.za/twinpeaks/Press%20release%20Twin%20Peaks%20implementation%20March2018_FINAL.pdf">financial markets</a>. Known as the Twin Peaks model, the decision has sparked debate, even controversy. </p>
<p>So what is Twin Peaks? And what’s all the fuss about?</p>
<p>The name Twin Peaks was adopted in 1995 by <a href="https://hk.linkedin.com/in/michael-taylor-75682714">Dr Michael Taylor</a>, who at the time was an official with the Bank of England. The name was a riff on the popular US mystery horror television mini-series <a href="https://www.imdb.com/title/tt0098936/">created by David Lynch</a>. </p>
<p>In a seminal paper published that year, Taylor set about unpacking the failings of the way banks and the financial markets were regulated in the UK. Regulation was based on a sectoral model – that is on the assumption that banks should be regulated separately from other kinds of financial institutions such as insurers. This model was used in most countries in the world at the time. It was applied in South Africa until 1 April 2018.</p>
<p>Twenty three years ago Taylor argued that the sectoral model was no longer fit for purpose. It was an anachronism. A throw-back to the days when there were clear delineations between different types of firms in the financial sector – banks, insurers, securities issuers. But when those firms began to amalgamate, the new firms that were created presented a problem for regulators whose authority was divided along lines that mirrored the division between banks, insurers and other financial firms. Taylor referred to this as a</p>
<blockquote>
<p>blurring of the boundaries.</p>
</blockquote>
<p>His observations were prescient. Even though his suggestions were rejected at the time, the intervening years – particularly the impact of the financial crisis in 2008 – have underscored the need for a rethink of how financial institutions are regulated. South Africa is in the process of catching up with what has become a growing trend. </p>
<p>Instead of having a separate regulator just for banks, the new system creates two peaks: one is now responsible for regulating to prevent financial crises (the prudential regulation peak), the other to ensure good market conduct and consumer protection (the good conduct peak). </p>
<p>South Africa has gone a few steps further to lay the foundation for a four peak model. This is because it envisages a role for the Reserve Bank in preventing financial crises as well as a role for the National Credit Regulator which already exists to protect consumers of credit. </p>
<h2>The history</h2>
<p>Taylor’s proposal was initially rejected in the UK. Instead the country’s government adopted the mega-regulator model, which brought all firms in the financial services sector under one umbrella. The International Monetary Fund touted this as the superior solution. Then came the global financial crisis in 2008.</p>
<p>The UK’s mega-regulator was abandoned as a disaster in the aftermath of the crisis and the collapse of <a href="https://www.telegraph.co.uk/finance/newsbysector/banksandfinance/11032772/The-rise-and-fall-of-Northern-Rock.html%3E%20and%20Halifax%20Bank%20of%20Scotland">Northern Rock</a>. A joint House of Lords, House of Commons <a href="http://www.publications.parliament.uk/pa/jt201213/jtselect/jtpcbs/144/144.pdf">inquiry</a> identified catastrophic failures by the country’s then regulator, the Financial Services Authority. It painted a picture of a regulator that had poor crisis management, and which had prioritised regulating business conduct over prudential regulation - regulations that are designed to force banks to act prudently, chiefly through making sure they have a minimum capital buffer.</p>
<p>The crisis, and the events it set in motion, led to a much deeper understanding of the tension between trying to enforce prudential regulation on the one hand, and protecting consumers on the other. The two functions are frequently mutually incompatible. And the failings of the mega-regulator showed that one was invariably sacrificed in favour of the other. </p>
<p>More often than not, when faced with a choice between helping several thousand aggrieved consumers, or avoiding a financial crisis, most regulators will choose to avoid a financial crisis - systemic failure in the system. Consumers – especially the most vulnerable consumers – are left unprotected. From a policy perspective, that’s a poor outcome. </p>
<p>But after the global financial crisis, and the sub-prime disaster that initiated it, we understand also that market misconduct and consumer abuse, when practised at scale, can become their own source of financial crisis.</p>
<h2>How Twin Peaks helps</h2>
<p>Twin Peaks is the only model that separates oversight into two independent regulators – market conduct and consumer protection on the one hand, and prudential regulation on the other. It envisions two regulators created as equals, with clear and unambiguous remits: one ensuring a sound and robust financial system, the other ensuring that the financial system is not distorted through market misconduct, while also protecting consumers of financial services and goods. </p>
<p>Twin Peaks was also the first regulatory model to adopt the view that a range of financial institutions – not just banks but also insurers - should be subject to regulations that would ensure they were fit for purpose, and could withstand a crisis. After the near collapse of the large <a href="https://www.wsj.com/articles/SB122156561931242905">US insurer AIG</a> in 2008, and its <a href="https://www.thedailybeast.com/remember-the-dollar182-billion-aig-bailout-it-just-wasnt-generous-enough">US$ 182 billion bail-out</a>, we now understand that some insurers are systemically important – that means that their collapse can lead to a domino effect of collapsing firms, and ultimately the market imploding. Prior to AIG’s collapse the assumption had been that only banks carried this level of risk to the system.</p>
<p>In the post-2008 world there is general acceptance that countries need to draw up much more specific terms and conditions for firms in the financial sector. Those terms and conditions are the basis of regulations to protect big firms from financial distress, because if they fail, taxpayers will be forced to step in and save them. In return, taxpayers have a right to impose regulations that will discourage conduct likely to lead to firms failing.</p>
<p>It’s appropriate that South Africa’s highly-advanced and sophisticated financial services sector should be regulated under an architecture that is fit for the present and the future. </p>
<p>Enforcement will be key. Twin Peaks can facilitate better enforcement, but doesn’t guarantee it.</p>
<p><em>This is one article in a series on the implementation of Twin Peaks in South Africa as well as difficulties the model is facing in Australia.</em></p><img src="https://counter.theconversation.com/content/95558/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Dr Andy Schmulow consults to Datta Burton and Associates. He is affiliated with Australian Citizens Against Corruption (ACAC), is an Executive Member of the Board of the Australian Law and Economics Association, and a committee member of the Banking and Finance Law and Studies Association (BFSLA) and the American Council on Consumer Interests (ACCI). He provides on-going ad hoc advice to members of the Australian Federal Parliament, principally in the Labor Party. He is currently a member of an expert panel of advisors convened to provide South Africa's National Treasury with advice on the drafting of the Conduct of Financial Institutions Bill, and made a series of submissions during the drafting of the Financial Sector Regulation Act.</span></em></p>Instead of having a separate regulator just for banks, the new system creates one to prevent financial crises, the other to ensure good market conduct and consumer protection.Andrew Schmulow, Senior Lecturer, Faculty of Law, The University of Western AustraliaLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/675932016-10-25T13:53:26Z2016-10-25T13:53:26ZWill Germany flout Europe’s bail-in rules if Deutsche Bank needs rescuing?<figure><img src="https://images.theconversation.com/files/143079/original/image-20161025-31489-twz1t6.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Troubled towers: the HQ in Frankfurt.</span> <span class="attribution"><a class="source" href="https://www.flickr.com/photos/xingxiyang/13568965704/in/photolist-mF3uLy-7ft4dF-9pzhx7-djvQ4m-7yaxPh-e7dDr5-aBA6JJ-7fK6oT-2N1sSa-osPyao-pk2LCy-89tXH-g8xTQz-7RYt47-f6fq2-iz15s-5gt8nn-9AFCXP-8W3tnr-7yay9J-7AeBzU-49C6Ro-d2si4-4cAwah-9ocaaM-qCb9-aH4tbP-4Tws41-cmfhYb-5iSTTR-6PqKBE-9MXaHr-9oVcVi-aWxvs2-gjPCso-9fFFfy-9H33Dr-bVSdFW-NhuML-ppxzDB-hKggUH-qPPT6L-avjozw-6Bvcsr-qVk8V-eqWDmB-9pzdHE-mS4fv-4cBURH-7V3XA">Kiefer</a>, <a class="license" href="http://creativecommons.org/licenses/by-sa/4.0/">CC BY-SA</a></span></figcaption></figure><p>Will Deutsche Bank need rescuing? It’s a question that is being asked as this big beast of global banking gears up to announce its third quarter results on October 27. With losses <a href="http://www.hitc.com/en-gb/2016/10/24/deutsche-bank-predicted-to-reveal-a-loss-this-week/">expected</a> to be north of €600m (£534m), the backdrop is dismal: Deutsche Bank is in talks with the US Department of Justice (DoJ) about a massive fine following an investigation into mis-selling toxic assets by the bank’s US division in the run up to the financial crisis of 2007-08. </p>
<p>The DoJ <a href="http://fortune.com/2016/09/16/deutsche-bank-doj-mortgages-case/">requested</a> US$14 billion (£11.4 billion) from Deutsche Bank to settle the case last month. The final settlement, which is due any time, <a href="http://www.cnbc.com/2016/10/20/deutsche-bank-vs-doj-heres-why-its-all-taking-so-long.html">may come in</a> somewhere around half that. But that would still be more than the €5.5 billion Deutsche Bank has set aside as a litigation reserve, and there are further losses still expected. </p>
<p>With shares <a href="http://www.cityam.com/252061/deutsche-bank-predicted-reveal-loss-week-and-doesnt-look">down by</a> close to half since the start of the year, albeit recovered a bit recently, there have been <a href="http://www.bbc.co.uk/news/business-37496268">reports that</a> the German government is planning a rescue by buying a stake if the DoJ fine is too onerous. The government denied this, but it raised an interesting question about what will happen if Deutsche Bank does fail. </p>
<p>Under <a href="https://www.ft.com/content/8ad2ed98-d0a0-11e5-986a-62c79fcbcead">EU rules</a> that came into effect in January, there can be no government bailouts of banks until there has been a bail-in – meaning other creditors to the bank such as bondholders and large depositors taking a share of the pain. The rules are highly controversial and I suspect the Germans will not want to impose them. If so, it will set the scene for an almighty row about double standards. </p>
<h2>Bailouts and bail-ins</h2>
<p>The new bail-in rules, known as the <a href="http://eur-lex.europa.eu/legal-content/en/TXT/?uri=CELEX%3A32014L0059">Bank Recovery and Resolution Directive</a>, are a response to the 2007-08 banking collapses. They were inspired by the UK’s <a href="http://www.legislation.gov.uk/ukpga/2009/1/contents">Banking Act 2009</a>, which was passed in the wake of the bailouts of the likes of RBS and Northern Rock. </p>
<p>Britain had previously been shamefully lacking in legislation to cope with bank insolvencies. The new act gave the Bank of England draconian powers to cope with future crises, including the right to modify the amounts owed to creditors on a struggling bank’s balance sheet. This was designed to avoid the need to inject public money in future by making others foot the bill instead. </p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/143080/original/image-20161025-31504-1kgxxh1.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/143080/original/image-20161025-31504-1kgxxh1.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/143080/original/image-20161025-31504-1kgxxh1.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/143080/original/image-20161025-31504-1kgxxh1.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/143080/original/image-20161025-31504-1kgxxh1.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/143080/original/image-20161025-31504-1kgxxh1.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/143080/original/image-20161025-31504-1kgxxh1.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/143080/original/image-20161025-31504-1kgxxh1.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Who rescues who?</span>
<span class="attribution"><a class="source" href="http://www.shutterstock.com/pic-312411911/stock-photo-an-emergency-tire-floating-in-a-pool-symbolic-photo-for-rescue-and-crisis-management-in-the-financial-crisis-and-banking-crisis.html?src=T2JJO0oqd57lXaO3EaFeHQ-1-44">Lisa S.</a></span>
</figcaption>
</figure>
<p>Under the EU’s 2014 directive, there can be no government bailout of a bank until at least 8% of its liabilities have been absorbed. This is a complete break from the past. It means that if a bank becomes insolvent and can’t raise fresh funds from its shareholders, certain liabilities may be reduced by the management in consultation with the country’s financial authority. </p>
<p>One of the main ways in which banks and other businesses raise capital is to issue bonds. Saving vehicles such as pension funds buy these in the expectation they will get the full amount back with interest at the maturity date. But not any more. Now even in a better scenario, the right of these most cautious of savers to be repaid might merely be downgraded to rank the same as all the ordinary creditors waiting to get their money back. The only bank liabilities that cannot now be modified are customer deposits up to roughly £90,000 and a few untouchable exceptions such as employee salaries. </p>
<h2>Double standards?</h2>
<p>Bailouts essentially protect bondholders to the detriment of the taxpayer, whereas bail-ins do the opposite. Before the new rules were introduced, several test cases showed how divisive bail-ins can be. Cypriot depositors were furious to <a href="http://business.inquirer.net/112981/savings-account-seizure-plan-draws-fury-in-cyprus">lose savings</a> en masse when Brussels insisted on a bail-in as a condition of bailing out Cyprus in 2013. There was <a href="https://www.ft.com/content/8ad2ed98-d0a0-11e5-986a-62c79fcbcead">similar uproar</a> and threats of lawsuits when bondholders of Novo Banco of Portugal had their assets written down last year. </p>
<figure class="align-right zoomable">
<a href="https://images.theconversation.com/files/143084/original/image-20161025-31486-18sx2an.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/143084/original/image-20161025-31486-18sx2an.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=237&fit=clip" srcset="https://images.theconversation.com/files/143084/original/image-20161025-31486-18sx2an.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=643&fit=crop&dpr=1 600w, https://images.theconversation.com/files/143084/original/image-20161025-31486-18sx2an.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=643&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/143084/original/image-20161025-31486-18sx2an.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=643&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/143084/original/image-20161025-31486-18sx2an.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=808&fit=crop&dpr=1 754w, https://images.theconversation.com/files/143084/original/image-20161025-31486-18sx2an.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=808&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/143084/original/image-20161025-31486-18sx2an.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=808&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Italians do it different.</span>
<span class="attribution"><a class="source" href="http://www.shutterstock.com/pic-172285184/stock-photo-piggy-bank-with-flag-coating-over-it-isolated-on-white-italy.html?src=m0osssv7EzLDXUIbCo_otA-1-8">Niyazz</a></span>
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</figure>
<p>And while it might make sense from a northern European legal perspective that taxpayer interests should prevail over bondholders, not all countries see it that way. In my native Italy, for instance, public saving has been heralded as a fundamental value for decades. Italy’s banking association <a href="http://www.politico.eu/article/italy-bank-crisis-renzi-bail-in-commission/">questioned whether</a> the EU bail-in mechanism is consistent with the country’s constitution. </p>
<p>There is also the feeling in southern Europe that there are double standards at play with the new rules. Where German and British banks needed bailed out after 2007-08, goes the narrative, the likes of the Italian banks weathered the crisis. They caught a different virus from 2011 onwards after being forced to buy toxic sovereign bonds issued by their governments to stay solvent during the eurozone crisis. </p>
<p>The sense is that British and German politicians and their respective bankers cleaned their respective “houses” with bailouts and promoted the bail-in once the job was done, thinking their banks wouldn’t have to deal with it. </p>
<p>Yet as Deutsche Bank is finding out, you never know what is around the corner. If the worst comes to the worst, I doubt the Germans will follow these Anglo-Saxon rules. It is more likely that there will be a German exception. </p>
<p>If so, it will be a classic example of how hard it is to make rules for the whole of the EU. I can hear the objections from the south of Europe already. Had it been an Italian or Spanish bank, they will say, it would have sparked the traditional tantrum against the peculiar Mediterranean way of interpreting rules and ultimately circumventing them. Unfortunately it will be hard not to agree with them.</p><img src="https://counter.theconversation.com/content/67593/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Pierre Sinclair de Gioia Carabellese does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>If Berlin doesn’t apply divisive rules that inflict pain on savers, expect cries of double standards from southern Europe.Pierre Sinclair de Gioia Carabellese, Associate Professor of Business Law, Heriot-Watt UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/132912013-04-08T20:34:56Z2013-04-08T20:34:56ZAfter a long line of financial disasters, UK banks on regulatory change<figure><img src="https://images.theconversation.com/files/22174/original/j5xg62ps-1365397815.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">The City has been plagued by financial disasters. Will the replacement of the Financial Services Authority with two new banking regulatory bodies be enough to stop the rot?</span> <span class="attribution"><span class="source">AAP Pictures</span></span></figcaption></figure><p>If the UK Financial Services Authority (FSA) had been a dog, it would have been about 86 years old when it was put down on April Fool’s Day this year. Uncharitably, some say that the FSA, the lead regulator for UK banks and insurers, was indeed a mutt that should have been dispatched long ago.</p>
<p>The short life of the FSA was book-ended by financial disasters.</p>
<p>After the failure of the venerable <a href="http://www.prmia.org/pdf/Case_Studies/Barings_Case_Study.pdf">Barings Bank</a> in 1995, regulation (or more correctly, self-regulation) of the banking industry in the UK was ripped away from the Bank of England (BOE) and the new FSA was given regulatory responsibilities by the Financial Services and Markets Act of 2000.</p>
<p>The FSA was brought undone, less than ten years later, by a number of financial debacles, not least the <a href="http://www.fsa.gov.uk/pubs/other/nr_report.pdf">Northern Rock</a>, <a href="http://www.guardian.co.uk/business/2012/nov/01/lloyds-ppi-mis-selling-5bn">PPI</a>, and <a href="http://www.cftc.gov/PressRoom/PressReleases/pr6289-12">LIBOR</a> scandals. As a result, the FSA was unceremoniously broken up by the UK government in the Financial Services Act of 2012.</p>
<p>The responsibilities given to the FSA by the UK Parliament, in 2000, were extensive and probably too broad. The FSA was not only responsible for regulating all banking and insurance corporations in the UK, but also for companies that operated investment and pension schemes. In its capacity as the UK Listing Authority (UKLA) , it was also responsible for ensuring that securities, such as equities, were issued by authorised firms. In 2012, the FSA employed about 4,000 staff in its many divisions to perform all of the functions allocated to it.</p>
<p>The main role of the FSA was as a “prudential” regulator, primarily concerned with maintaining financial stability and market confidence in the UK financial system. It also had secondary responsibilities for consumer protection (with regards to financial products) and the reduction of financial crime. The FSA exercised these <a href="http://www.fsa.gov.uk/pages/about/aims/statutory/index.shtml">statutory objectives</a> by setting so-called “prudential standards”, which involved ensuring that banks and insurers were adequately capitalised for the risks that they were taking and were properly reporting their risks to their shareholders. Clearly, the FSA failed in its basic prudential regulation as some of the UK’s largest banks went to the wall during the GFC.</p>
<p>The FSA’s remit was enormous. But it should be remembered that regulators do not choose what they do, but are chartered by governments to do what governments want to do. If the job of overseeing the many thousands of UK financial companies, large and small, was too big for the FSA, it was the fault of the UK government and parliament, not the regulators themselves.</p>
<p>Interestingly, the FSA was not funded by the UK government, but by the firms that it regulated, through imposition of levies. Such a funding model is not without problems, as it would encourage any regulator to expand its remit rather than focus on the areas of greatest financial risk.</p>
<p>So what went wrong?</p>
<p>In the aftermath of so many scandals, it is extremely difficult to remember back to the halcyon days of banking before the GFC. Back in 2006, the landscape of banking was very different.</p>
<p>For a start, it was assumed that banks would compete fiercely with one another but would deal with their customers and shareholders honestly, or at least not do harm to them. Why on earth would anyone want to harm their own customers, since that is the very source of their long-term profitability?</p>
<p>Such an idea had to be unthinkable, but that is exactly what happened in many banks around the world. Take Goldman Sachs, which sold securities to “valued customers”, while at the same time <a href="http://www.sec.gov/news/press/2010/2010-123.htm">betting against</a> those very securities. If only Goldman had been the exception — but it was not. Almost every major bank in the world has been accused in the past few years of similar wrongdoing, if not on the same gob-smacking scale.</p>
<p>As private companies, banks were impervious to criticism before the GFC. As Lord Turner, last chairman of the FSA, told legislators, the hands of the regulators were tied:</p>
<blockquote>
<p>“The global philosophy of regulation which was based upon too extreme a form of confidence in markets and confidence in the ideas that markets were self-correcting. This, in turn, had led to a belief that firms themselves could be left to make fundamentally sensible decisions.”</p>
</blockquote>
<p>In other words, the market — not regulators — would sort out any problems.</p>
<p>In fact, banks behaved abominably, selling <a href="http://www.fsa.gov.uk/static/pubs/other/interest-rate-hedging-products.pdf">dodgy financial products</a> to customers who often did not need the products and more often didn’t understand them. Unlike other goods, such as a motorcar, if a financial product blew up it was the fault of the customer rather than the seller, in the eyes of the bankers. The markets did not regulate misbehaviour because all the banks were all doing it.</p>
<p>Looking back, it was an Alice in Wonderland world where banking was just getting “curiouser and curiouser”.</p>
<p>After all the crises and the injection of billions of dollars of taxpayers’ money, politicians came to the blindingly obvious conclusion that bankers could just not be trusted to do the right thing. Some new regulations were needed to ensure that bankers behaved themselves.</p>
<p>In an example of kicking a dying man when he is down, the UK Parliamentary Commission on <a href="http://www.parliament.uk/bankingstandards">Banking Standards</a> has just issued a <a href="http://www.publications.parliament.uk/pa/jt201213/jtselect/jtpcbs/144/144.pdf">report</a> into the failure of Halifax Bank of Scotland (HBOS), entitled “An accident waiting to happen”.</p>
<p>This report not only roasts the Board and management of HBOS, but also crucifies the already dead FSA. “The picture that emerges is that the FSA’s regulation of HBOS was thoroughly inadequate [and] from 2004 until the latter part of 2007 the FSA was not so much the dog that did not bark as a dog barking up the wrong tree”.</p>
<p>The committees’ overall comment on the management of HBOS was that the bank was a ‘Manual for Bad Banking’ and that the bank’s culture “was brash, underpinned by a belief that the growing market share was due to a special set of skills which HBOS possessed and which its competitors lacked. The effects of the culture were all the more corrosive when coupled with a lack of corporate self-knowledge at the top of the organisation, enabling the bank’s leaders to persist in the belief, in some cases to this day, that HBOS was a conservative institution when in fact it was the very opposite”.</p>
<p>However, the FSA was not wholly to blame, as the committee admitted that “the experience of the regulation of HBOS demonstrates the fundamental weakness in the regulatory approach prior to the financial crisis and as that crisis unfolded”.</p>
<p>It is not only politicians and regulators that have to come to this conclusion. Last week, an independent <a href="https://www.salzreview.co.uk/web/guest">review</a> of Barclays’ business practices, headed by noted lawyer Anthony Salz, was published. The review, initiated by Barclays, discovered a plethora of bad practices in the recently repentant bank, from misselling of financial products to retail and business customers, rigging LIBOR, misreporting of assets, tax avoidance and more.</p>
<p>Mr Salz concluded: “Pay contributed significantly to a sense among a few that they were somehow unaffected by the ordinary rules. A few investment bankers seemed to lose a sense of proportion and humility.”</p>
<p>So how should such blatant misconduct and incompetence be regulated in future?</p>
<p>Since it was obvious that the FSA was too big and unwieldy already, the solution taken by the UK government was to split regulation across two major organisations.</p>
<p>In the new structure, prudential regulation was hived off to the Prudential Regulatory Authority (PRA) and, in an illustration that governments never learn the lessons of history, this body was handed back to the Bank of England, now rehabilitated after the Barings fiasco.</p>
<p>The second major regulator is new. It is the Financial Conduct Authority (FCA), whose remit is to “promote innovation and healthy competition between financial services firms. We help them keep to the rules and maintain high conduct standards”. This new regulator will be headed by none other than <a href="http://cdn.hm-treasury.gov.uk/wheatley_review_libor_finalreport_280912.pdf">Martin Wheatlev</a> who headed the LIBOR inquiry, so he is well aware of how big the task is going to be.</p>
<p>Of course, in regulation, one can never have enough acronyms and to oversee these two new regulators there is yet another regulator, the FPC (or Financial Policy Committee) which is to be part of the Bank of England. In other words: BOE 2, FSA 0.</p>
<p>Just to complete the carve up of the FSA, the small part of the old regulator that dealt with financial education has been split off as the separate Money Advice Service (MAS) whose remit is to “help people make the most of their money, we give free, unbiased money advice to everyone across the UK – online, over the phone and face to face”. It should be noted that in the USA, a similar independent body, the Consumer Financial Protection Bureau (<a href="http://www.consumerfinance.gov/">CFPB</a>), was set up under the elephantine <a href="http://www.pwc.com/us/en/financial-services/regulatory-services/publications/dodd-frank-closer-look.jhtml">Dodd Frank Act</a>.</p>
<p>In this new regulatory world, UK and US banks need to be better corporate citizens and take the advice of Alice in Wonderland: “I can’t go back to yesterday because I was a different person then”. But until banks become “different persons: they will need robust regulation of their conduct, and hopefully they will get it.</p>
<p>There are lessons for Australia’s banking regulators, too. In the HBOS report, the parliamentary committee makes several comments on the disastrous lending policies of the bank, singling out Australia, where some 28% of business loans were eventually impaired.</p>
<p>It should be remembered that the Australian Prudential Regulation Authority (APRA) was the regulator for Bankwest (the local subsidiary), while "HBOS followed an ambitious growth strategy in Ireland and Australia, involving over-optimistic targets and assumptions for market share growth from local competitors”.</p>
<p>Surely such a risky strategy should have raised eyebrows at APRA headquarters? Not least when Bankwest was later acquired by Commonwealth Bank, albeit at a knockdown price and, as it later turned out, <a href="http://www.smh.com.au/action/printArticle?id=1772627">massive losses</a>.</p>
<p>The issue of the now Australian-owned Bankwest and its treatment of local borrowers was vociferously raised during last year’s <a href="http://www.aph.gov.au/Parliamentary_Business/Committees/Senate_Committees?url=economics_ctte/post_gfc_banking/hearings/index.htm">Senate Inquiry</a> into the Australian banking system. Following the many allegations raised, not only on Bankwest, the final recommendation of the Senate Committee was that, “an independent and well-resourced root and branch inquiry into the Australian financial system be established”.</p>
<p>Where is that inquiry?</p><img src="https://counter.theconversation.com/content/13291/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Pat McConnell does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>If the UK Financial Services Authority (FSA) had been a dog, it would have been about 86 years old when it was put down on April Fool’s Day this year. Uncharitably, some say that the FSA, the lead regulator…Pat McConnell, Honorary Fellow, Macquarie University Applied Finance Centre, Macquarie UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/120872013-02-11T04:49:13Z2013-02-11T04:49:13ZUK banking reform bill won’t curb reckless risk-taking<figure><img src="https://images.theconversation.com/files/20050/original/jdr86p6k-1360282652.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">More of the same: the UK government's banking reform bill is merely another capitulation to the banking lobby. </span> <span class="attribution"><span class="source">AAP</span></span></figcaption></figure><p>Some four and-a-half years after the banking crisis that has resulted in massive public debt and a deep austerity program, the UK government has finally unveiled its <a href="http://www.publications.parliament.uk/pa/bills/cbill/2012-2013/0130/2013130.pdf">Financial Services (Banking Reform) Bill</a> . The Bill is going through parliament and is expected to become law by the end of the year.</p>
<p>The legislation will require UK banks to insulate everyday banking activities associated with savings, deposits and loans from more volatile investment or speculative activities, by introducing a ringfence around the deposits of individuals and businesses. Thus two subsidiaries under the same parent company are envisaged. This separation is advocated because investment banking indulged in excessive risk-taking and accelerated the banking crisis. </p>
<p>Bear Stearns, Lehman Brothers and Northern Rock are often held out as exemplars of this reckless risk-taking. Prior to its <a href="http://news.bbc.co.uk/2/hi/business/7007076.stm">demise</a>, Northern Rock had a leverage ratio (the relationship between total assets and shareholder funds) of 50 while Bear Stearns and Lehman had leverage ratios of 33 and 30 respectively, thus making them highly vulnerable to small declines in the value of their assets. </p>
<p>For five years before its <a href="http://online.wsj.com/article/SB124182740622102431.html">collapse</a>, Bear Stearns generated almost all of its income from speculative activities. About 80% of Lehman’s income came from speculative activities. Other banks also indulged in an orgy of speculation and, by December 2007, the global face value of derivatives stood at <a href="http://www.bis.org/statistics/derstats.htm">$1148 trillion</a>, compared to a global GDP of only $65 trillion. No one can consistently pick winners and, when their financial fortunes turned, it set off a domino effect. </p>
<p>Many counter parties to complex financial instruments were in danger of defaulting on their obligations and thus threatened the collapse of whole system. The UK government bailed out the system with loans and guarantees of nearly £1 trillion.</p>
<p>Critics claim that ringfencing will increase administration costs and capital ratios, leading to reductions in the amount of credit in the economy and thus investment and jobs. The Bill is based on the premise that, in the next banking crisis, the government would rescue the retail side, but would probably let the investment side sink. This threat may discipline banks and spare taxpayers the expense of bailing out the entire system. The ultimate sanction is that if banks do not ringfence satisfactorily by 2019, then the regulator can formally split their operations.</p>
<p>The Bill sounds good, but is unlikely to be effective. It does not impose any personal costs for reckless risk-taking. Ringfencing is not the same thing as a legally enforced separation (two independent entities operating retail and investment banking). The Bill does not say what precisely is to be ringfenced as savings can be placed in many exotic securities. </p>
<p>Derivatives have been described by the US investment guru Warren Buffett as “financial weapons of mass destruction”, but the government has yielded to the banking lobby and will permit banks to locate “simple” derivative products — whatever “simple” means — within their retail banking operations. </p>
<p>What if funds flow from a ringfenced entity to non-ringfenced entity via a foreign subsidiary or affiliate in a place where there is no such separation? Would this be a breach of the ringfence? The Bill does not provide any examples of what a breach of ringfencing looks like, though the Treasury will have powers to prohibit unspecified types of transactions.</p>
<p>The lack of precision will fuel uncertainty and encourage banks to play creative games in deciding which side of the ringfence some assets and liabilities are to be shifted. The regulator is expected to negotiate the details with the banking industry.</p>
<p>Ringfencing will neither hermetically seal investment banking nor prevent its contagious effects from spreading. For its speculative activities, investment banks will continue to raise finance from retail banks, pension funds, insurance companies and others. They will still have the benefit of limited liability. </p>
<p>In the event of losses or a crash, investment banks will be able to dump their losses on to the providers of finance and thus infect the whole financial system, and will inevitably force governments to bail out the system again. The only remedy is to ensure that investment banking is accompanied by unlimited liability: investment banks are free to speculate as long as their owners can personally absorb the losses.</p>
<p>Investment banks may entice corporate executives to provide funds with promises of huge returns, which might boost their performance-related pay, but can land stakeholders with huge losses. Therefore, the Bill should have required that prior to transacting with investment banks, organisations should seek permission from their own stakeholders. </p>
<p>This would have prevented innocent bystanders from becoming the victims of speculators. Perhaps effective reforms will come after the next banking crash.</p><img src="https://counter.theconversation.com/content/12087/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>I receive financial services from banks but do not own shares in any. I do not act as a consultant to any bank and have neither sought nor received research grants from any bank.</span></em></p>Some four and-a-half years after the banking crisis that has resulted in massive public debt and a deep austerity program, the UK government has finally unveiled its Financial Services (Banking Reform…Prem Sikka, Professor of Accounting, Essex Business School, University of EssexLicensed as Creative Commons – attribution, no derivatives.