It seems a bit odd for one of the key figures in the UK’s newly installed financial regulatory structure to be calling for drastic reform of bank regulation already, but the Bank of England’s Andy Haldane seems to be calling them like he sees ‘em nonetheless.
Haldane is executive director of financial stability for the Bank’s Financial Policy Committee (FPC), the forward-looking systemic risk identifier created alongside the FCA and PRA as a result of 2012’s Financial Services act.
Given his position, it was interesting to hear him identify a “Byzantine” regulatory structure as a credible threat to the stability of the banking system, at a dinner held by the International Financial Law Review (IFLR) yesterday.
Complex regulation, he said, has only acted to the advantage of those with most resources to devote to exploiting gaps in the rules, arguing instead that “Simple measures of bank leverage, untainted by such complexity, were ten times better at predicting banking failure during the crisis than complex regulatory alternatives.”
Along with proposing a leverage ratio “north, possibly well north” of international requirements (a view that makes sense given Haldane’s work on the Basel committee), he suggested a “restructuring rule” facilitating simple wind-downs of banking operations, and a “resolution rule” governing restructuring, as the main building blocks of a stripped-down regulatory system.
Perhaps the most insightful back-to-basics comment made by Haldane this week, however, came at an event held the day before the IFLR dinner by the Federal Reserve Bank of Atlanta.
Speaking on the subject of executive bonuses, he built on comments made in January (regarding the proposed deferral of bonuses by ten years to encourage prudence) to suggest that debt, rather than equity, should make up the mainstay of management compensation structures.
“Equity can give strange incentives” to the management of banks in crisis, he argued, adding that during the financial crisis, “many big firms gambled for their resurrection when, if you look at how top management was remunerated, it was heavily in equity.”
Debt elements facing wipeout in the event of business failure, he explained, could act as a major counter to these “strange incentives” if built into pay structure, concluding that “more can and should be done to have those sorts of debt form a larger part of compensation structures.”
This approach – to look at the incentives that drive how banks behave, rather than creating a web of rules to restrict what is possible – feels very much in line with the current zeitgeist.
Steven D. Levitt, the economics world’s answer to Jeff Goldblum’s character in Jurassic Park, had this to say in the first chapter of bestselling pop-econ book Freakonomics:
“The typical economist believes the world has not yet invented a problem that he cannot fix if given a free hand to design the proper incentive scheme. His solution may not always be pretty -- it may involve coercion or exorbitant penalties or the violation of civil liberties -- but the original problem, rest assured, will be fixed. An incentive is a bullet, a lever, a key: an often tiny object with astonishing power to change a situation.”
With this in mind, it’s tempting to think that a creative look at executive remuneration, a subject which currently enrages a large slice of the world’s population, and which has been blamed for a lot of the misery to affect global markets since 2008, may be the tool capable of cutting the Gordian knot of post-crisis regulation.