Regulators plan crackdown

05/10/2009 | Anthony Rowley, Sid Verma

Global regulators set out their ambitions to impose tough banking reforms in Istanbul yesterday, in response to fears that a lack of political will to dethrone giant, unwieldy banks could sow the seeds of another crisis

Global regulators set out their ambitions to impose tough banking reforms in Istanbul yesterday, in response to fears that a lack of political will to dethrone giant, unwieldy banks could sow the seeds of another crisis.

The head of a key US regulator argued for weakening the protection enjoyed by holders of secured instruments issued by “systemically important” banks, while the chief regulator for the G20 said that the largest institutions should face the toughest measures.

Sheila Bair, head of the US Federal Deposit Insurance Corporation, urged at an International Institute of Finance seminar that the claims of secured creditors of US banks be limited to 80% in the event of bankruptcy.

This would reduce the risk of “moral hazard” of systemically important institutions deemed too big to fail, as it would ensure that “market participants always have skin in the game,” she said.

Bair also called for a contingency fund for bankrupt banks, to finance their daily operations and working capital while bankruptcy claims are being negotiated. This would help avoid a repeat of the calamity that ensued after the collapse of Lehman Brothers.

Mario Draghi, chairman of the Financial Stability Board, asked at a press briefing whether the G20 countries should enforce the limitation of bank creditors’ claims, told Emerging Markets that this “one option” should be considered in addition to “higher capital charges” and other such measures.

Draghi’s views are crucial, as he is chairman of an expanded regulatory body recently set up by the G20 to propose measures in the next 12 months on how to remove systemic risks in the banking sector.

He said the FSB would tailor regulations based on the specific systemic risk each institution poses. “You have very large financial institutions that are not systemically important, because they are built on a network of subsidiaries, each one with their own liquidity and capital policies, or you have the small institutions that are very important from a systemic view point because they are at the centre of complex web of credit default swaps and derivative trading,” he said.

His comments came amid accusations that regulatory reform has lost steam. This weekend, IMF managing director Dominique Strauss-Kahn, said “complacency” had set in among policy-makers amid signs of global economic recovery.

Raghuram Rajan, professor of economics at the University of Chicago, told Emerging Markets that the momentum for bold regulatory action on the global and domestic level had been lost. “This crisis is costly but not costly enough” to arouse politicians out of their slumber, he told said.

Lorenzo Bini Smaghi, an ECB governor, blamed this on political pressure. “The regulations were not used [in the run up to the global crisis] Why? Because no-one wanted the regulations to be used,” he said in Istanbul yesterday.

“We need more independent regulators – independent from politicians. But I see no evidence of this [happening].”

“There has been competition to the bottom ... between US and Europe” to grow their financial industries. This had undermined the political will to launch bold reforms, Smaghi said.

William Rhodes, senior vice chairman of Citigroup warned: “If we don’t do regulatory reform now, it will be too late.”

Malcolm Knight, vice-chairman at Deutsche Bank, suggested the problems of moral hazard continue to rage amid a resumption of risky banking activities by government-backed institutions.

“Any institution that makes profits on proprietary trading on taxpayers money and then distributes the profit in the form of bonuses – that is a moral hazard,” he said yesterday.

“The belief in the ‘too big to fail’ concept has been reinforced by the events of last year, and we need a resolution regime for resolving failed banks without imposing costs to taxpayers,” said Bair.

ECB governor Smaghi argued that sweeping changes were needed to integrate the shadow banking system, as well as limit the risk of regulatory arbitrage.

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Parts of the democratic process are under siege.

Radmila Sekerinska, president, National Council of European Integration