G20 looking at global bank rules but regulator emphasises culture

Photo: Mark Carney, governor of the Bank of England, speaks at the International Symposium of the Bank of France policy conference in Paris, France, on Friday, Nov. 7, 2014. Photographer: Kosuke Okahara/Bloomberg via Getty Images.

The FSB was originally slated to have finished making the system safer by now and indeed it has done much work. FSB chairman and Bank of England governor Mark Carney will present to the G20 on a range of measures but many are still being implemented.

The most critical of these is the paradox of 'too big to fail' – financial institutions so inextricably woven into financial systems that their outright failure would drag down the system too. During the crisis, taxpayers in many large northern-hemisphere economies had to bail out these banks.

But on Monday in Basel, Carney announced a “watershed” moment in addressing this problem, a range of measures directed at so-called “globally systemically important banks” or G-SIBS. The FSB has identified 30 of these – none in Australia – and the board proposes a safety net known as “total loss-absorbing capacity” or, in another acronym, TLAC.

TLAC, Carney argued, needs to be a mixture of equity capital and debt structures of sufficient scale to eliminate the risk to taxpayers. For G-SIBS this is expected to equate to about a quarter of a bank’s assets after the assets are 'risk weighted' – that is, less risky loans don’t need as much insurance.

This new regime fits in with what are known as recovery and resolution plans; templates laid out by banks and their supervisors to understand how they fit into the system and how they could be dismantled or rescued if they get into trouble.

However, what Carney announced on Monday is a set of draft proposals. These are open to comment until February and won’t be implemented in full until 2019.

So the FSB presentation to the G20 will still be about work in progress.

Deloitte's risk and regulatory leader, Kevin Nixon, who for the past couple of years worked for the banking industry’s major international lobby group, the Institute of International Finance, liaising with Basel, says of four main pillars of work, only two are really complete.

Nixon told BlueNotes the four pillars were making institutions more resilient; solving too big to fail; formalising the trade in opaque derivatives; and controlling shadow banking, the risk being taken outside the regulated sector.

“As far as too big to fail and shadow banking goes, there is still much to do,” he says. “Some of the work is really completing Basel III (the current iteration of global banking regulations) meanwhile there are now new fronts opening on looking at insurance and funds management.”

Carney will update the G20 on all this and it is also possible he will address something the banking industry – and increasingly regulators and other officials – have been emphasising: stepping back and looking at the impact and interaction of new regulation introduced over the last few years, often to address specific problems and sometimes counter-acting other new rules.

It is possible a new body may even be created to monitor implementation and consequences – intended and otherwise.

“How does all this fit together? That’s a very big question,” says Nixon.

Indeed Nixon’s role at Deloitte is about a subject growing in profile: 'regulatory productivity'. Those looking at bank earnings will increasingly have to assess how well an institution implements its compliance, its regulatory spend, its risk management and, critically, what budgets is that money coming off?

While Australian banks are not G-SIBS, they are domestically systemically important. This is not an issue for the G20 but it is front and centre of the major regulatory uncertainty in Australia, the recommendations of the Murray Financial System Inquiry.

Media speculation based on inquiry sources suggests Murray is looking at many of those issues pre-occupying the FSB even though the FSB’s agents in Australia are the Australian Prudential Supervision Authority and the Reserve Bank of Australia.

The FSB in announcing its intention was clear and specific: “By strengthening the credibility of authorities’ commitments to resolve G-SIBs without exposing taxpayers to loss, TLAC in conjunction with other measures should act to remove the implicit public subsidy from which G-SIBs currently benefit when they issue debt and incentivise creditors to better monitor G-SIBs’ risk-taking.

“It should also help achieve a level playing field internationally, reducing G-SIBs’ funding cost advantage and ensuring they compete on a more equal footing within their home and foreign markets. TLAC adequacy will need to take account of individual G-SIBs’ recovery and resolution plans, their systemic footprints, business models, risk profiles and organisational structures.”

It is difficult to predict how this global body of work will feed through into Australian regulation given not just its different target but national idiosyncracies.

However in his press conference on Monday, Carney made some critical observations which should inform any regulatory response anywhere.

Carney said central banks and regulators globally needed to cooperate more in probing and punishing “bad behaviour” at banks.

"We need the fixes to bank conduct but we also need to ensure that, to the maximum extent possible, there is coordination across authorities, both in terms of identifying, investigating and punishing misconduct," he said.

"We are undertaking a series of reforms that change the way markets work, which reduce the opportunity of misconduct, but that's not the same as having the right culture codes in order to perceive it. This has risen to the level of financial stability and we need a comprehensive approach to address.”

It’s good and proper Carney, as head of the FSB, should make this point. It must be remembered the financial crisis was more about culture than regulation. Many of the banks which failed were highly capitalised. What was common to failed institutions was a failure by management to understand and price risk.

What was common to failed financial systems was a lack of regulatory coordination and poor supervision – two things Australia and Canada (from whence Carney hails) can claim to have done well.

These new rules on G-SIBS, when finally agreed upon, may well be applicable to Australia but that is far from clear and concentrating on specific rules and measures shouldn’t take precedence over a proper stock take of the culture and architecture of regulation.