Blog: Overregulation of banks might have diminishing benefits – GlobalCapital

In the wake of the financial crisis in 2008, regulators in the largest financial hubs put strict regulations in place to prevent a repeat of the fiscally irresponsible lending habits that arguably led to the crash in the first place.

One of these initiatives, wrapped up in the US by the Dodd-Frank Act, included on a global level as part of the 2010 Basel Committee on Banking Supervision’s official regulatory standards, and introduced in the UK in 2014 as part of the Capital Requirements (Capital Buffers and Macro-prudential Measures) Regulation, was to ensure that banks maintained sufficient liquidity levels to meet their capital requirements, or capital buffers.

The regimes were strict but, at the time, deemed necessary. The chief legal officer of one bank admitted that exercises such as stress testing had become much more rigourous as a result, which he welcomed.

Alongside regular stress testing, capital buffers have meant that banks are now better positioned to handle certain problems, are more solid, more stable and tend to be more resilient. However, despite the success, regulators today seem very keen to install even more measures designed to bolster existing rules and improve liquidity.

The US Federal Reserve is reviewing its rules, and the Basel Committee plans overhauls to its Basel IV regulation, which according to Nordea means that the European banking system will need an estimated 19% of additional Tier 1 capital.

The general counsel at a large US bank recently told GlobalCapital that even as a registered Democrat — the party usually associated with strong regulation in the US — he thought that things were getting out of hand under the Gary Gensler’s stewardship of the Securities and Exchange Commission. There have been loud calls around the US financial markets to slow down with the onslaught of regulations coming from the agency, and its peers.

“It’s coming from a good place,” said the general counsel, “in terms of the intention to keep things safe and sound, particularly as we move through a period of uncertainty. But there is a point where you over-protect and you get diminishing benefits for extraordinarily more calories being consumed, that could be spent elsewhere.”

Increased regulation could mean that banks are distracted by the incremental measures that they will be required to implement and end up missing the bigger picture — which could lead to further problems down the line. Likely, problems that outweigh the benefits of the rules they are trying to strengthen.

Banks want to ensure their commitment to shareholders of communities and to clients, and above all want to remain in business. but regulating for the sake of it will bring problems.

As it stands, despite market turmoil and external volatility, banks are well capitalised and do not tend to want greater capital buffers. When it comes to overall regulation, one of the things that banks advocate for and what they want to see more of is a dialogue between the main regulators and a level playing field across the world. For global banks in particular, when there are multiple regimes and capital requirements, it becomes much more challenging to manage.

The next step for regulators should not be about increasing capital reserves, or going ever further into dictating how banks should operate but about introducing prescriptive and more specific guidance about how to use the reserves already in place. Stress testing may be a key feature nowadays of bank regulation but banks complain that it can be very difficult to use those capital buffers at short notice in real life.

“Regulators need to be much more specific in their guidance of when you when can you actually bring the buffer down, which will actually allow banks to use those buffers,” said another banker. “Today, there’s a stigma attached to using those buffers, banks will curtail business rather than actually go below them and use liquidity from vendors, etc.”

Rather than introduce greater controls, regulators would do better to come out with more prescriptive, more specific guidance during the stress period.

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