Are we prepared for the next financial crisis?
From consumer advocates to the media, many claim to be the vigorous protector of the little man’s rights. Yet the intricate mechanics of financial regulation require a softer touch
© Michael Danner/laif
Meet Jacques de Larosière, a highly regarded former head of the International Monetary Fund. A powerful background voice in terms of European financial oversight, he tends to be more of a thoughtful grandfather figure than defender of simple truths.
Examples of unintended regulatory consequences abound in the post- era. Forcing European banks to match the duration of their assets and liabilities effectively shortens credit durations, according to de Larosière. He points to decreasing rates of bank lending in the eurozone since as evidence. Assigning a near-zero risk weighting to government bonds is another, as it herds investors into a single asset class. Additionally, equity investment is discouraged and bank balance sheets are increasingly driven by regulatory requirements rather than economic needs, leading to rising inefficiencies.
“This is not what we wanted,” he comments on reviewing the regulatory consequences of the last few years. It is the result of different pieces of regulation, each valid in its own right, but its cumulated global effects have not been sufficiently understood. “This can create ugly surprises,” de Larosière warns.
GENTLE WATCHDOG
© ullstein bild - Reuters / BENOIT TESSIER The 85-year-old Frenchman has vast experience in the field. His last major salvo was as chair of a working group tasked by the European Commission to propose stronger financial supervision. Their report, titled The High-Level Group on Financial Supervision in the EU , but referred to as the de Larosière Group report, recommended tighter financial control, resulting in one of the most ambitious rounds of banking reform in Europe’s history and greater European financial integration.
De Larosière and his group came up with 31 recommendations which aimed to better protect citizens and rebuild trust in the financial system. They called for the creation of three separate authorities watching over banks, insurers and securities markets. Following their advice, the European Banking Authority (EBA), EIOPA and the European Securities and Markets Authority (ESMA) started to operate.
The European System of Financial Supervision and European Systemic Risk Board were set up to identify financial instability and anticipate turbulence. Other proposals urged EU states to establish criteria such as who bails out a failed cross-border bank. And they also called for more cross- border integration, greater hedge fund transparency and urgent reform of the Basel II framework on capital requirements for banks, such as stricter rules for off-balance- sheet items.
I think the financial sector is stronger and better-prepared for the next crisis than it was before
HOW DID IT GO?
Six years after his report, de Larosière told PROJECT M he is content with the results. Now president of Paris-based Eurofi, a think-tank financed by banking, insurance and asset management members, his opinions still resonate with policymakers and regulators.
Yet there are open issues. A European Commission report, on the Operation of the European Supervisory Authorities and European System of Financial Supervision , suggests measures to cut organizational slack while also acknowledging that there is a lack of budget and human resources. De Larosière would also like to see European regulators have a greater ability to investigate financial firms directly.
He also warns of an excessive focus on short-term market risks when it comes to insurers’ assets, as this might deter them from holding equity for the long term. “On one side, governments want to introduce more equity in the system, while at the same time they are also introducing regulations that prevent equity being held by insurance companies, one of the natural buyers of equity,” he says.
Regulators point to regular consultations with their stakeholders to amend such issues, yet this is not a perfect process, according to de Larosière. “We need to get over the dichotomy of the financial industry defending their profits by all means and the regulators acting as the sole defenders of public interest. Our dialogue needs to be more constructive than that.”
