October 23, 2013

We need more trigger happy bank regulators

Sir, I refer to John Kay’s “To secure stability, treat finance and fast food alike” in which he writes “Perhaps the most fundamental confusion in the evolution of financial services regulation is the equation of financial stability with the survival of established institutions.”

He is absolutely correct. In May 2003, days when Basel II was being discussed, as an Executive Director of the World Bank, addressing a workshop with some hundred bank regulators, I told those present:

“If the path to development is littered with bankruptcies, losses, tears, and tragedies, all framed within the human seesaw of one little step forward, and 0.99 steps back, why do we insist so much on excluding banking systems from capitalizing on the Darwinian benefits to be expected?

There is a thesis that holds that the old agricultural traditions of burning a little each year, thereby getting rid of some of the combustible materials, was much wiser than today’s no burning at all, that only allows for the buildup of more incendiary materials, thereby guaranteeing disaster and scorched earth, when fire finally breaks out, as it does, sooner or later.

Therefore a regulation that regulates less, but is more active and trigger-happy, and treats a bank failure as something normal, as it should be, could be a much more effective regulation. The avoidance of a crisis, by any means, might strangely lead us to the one and only bank, therefore setting us up for the mother of all moral hazards—just to proceed later to the mother of all bank crises.

And knowing that “the larger they are, the harder they fall” if I were regulator, I would be thinking about a progressive tax on size. But, then again, I am not a regulator, I am just a developer.”

But they were too much in love in their own risk-management capabilities to listen to someone who was not even a PhD.