The R-word is back. Not recession but regulation. Thanks to the unprecedented
scale of the financial crisis, policymakers on both sides of the Atlantic find
themselves with the whip hand over business for the first time in a generation.
The credit crunch has thrown into doubt the merits of deregulation and
light-touch control that has governed business and financial services in
While the economic outlook may be brightening, there seems no end in sight
for tighter credit conditions, soaring market interest rates and a general
flight from the risks that have gripped the system since last August.
“The market is still adjusting,” Don Kohn, a senior member of the US Federal
Reserve said in April. “It is still too early to know. It is not over yet.”
Any doubts were dispelled in May by a Fed survey showing 60% of banks
tightened their criteria for lending to commercial and industrial firms in the
second quarter compared with less than one-third in the first three months of
On this side of the Atlantic, money is still expensive. Despite the Bank of
England’s cuts in official interest rates from 5.5% to 5.0% this year, the cost
of borrowing money over three months is unchanged at 5.9%. The two rates are
normally closer together.
But the continued freeze in credit markets will not only act as a drag on the
economy, it will also provide the platform for regulators to rein in the most
egregious bad practices of the last few years.
First out of the blocks was the Financial Stability Forum, a grouping of
central bankers and regulators, which delivered a damning verdict on the banks
and demands for drastic surgery.
The executive summary alone was 11 pages long and its list of demands
included greater capital requirements, better liquidity management and reform of
the way ‘star’ bankers are paid, to name three.
As Tim Geithner, the Fed’s vice chairman and co-author of the report, put it:
“We have to get a better balance between market discipline and regulation, and a
better balance between efficiency, innovation and stability.
“I don’t think that anybody can look at the system and say we got the balance
There is little doubt where European policymakers stand when it comes to
deciding between stability and regulation or innovation and self-discipline.
Many are angry that their own banks have been hurt by what they see as yet
another American-made crisis on the lines of Black Monday, Long Term Capital
Management and the dot.com crash.
One experienced Brussels-watcher says the issue of financial regulation in
Europe is at an “inflection point in the policy cycle”.
Europe has enjoyed a brief flirtation with the style of light-touch
regulation practised in London mainly thanks to Charlie McCreevy, the internal
market commissioner who has resisted calls for pan-European banking regulation.
Critics believe the banking sector gave too much of a role to self-regulation
and that that has resulted in the growth of financial engineering to the benefit
of the engineers and the detriment of EU business generally.
Combined with this are elections to the European parliament and selection of
a new commission. In the current climate, the next generation of commissioners
and MEPs will be more interventionist.
This will focus on financial issues such as a pan-European financial
regulator to sit above national bodies including the UK’s Financial Services
Ieke van den Burg, a leading Dutch socialist MEP, says Europe failed to react
to the crisis because its 27 national supervisors did not have the powers or
tools to deal with the issue on a European basis.
“We need to have, like the European Central Bank, a real, independent
supervisory structure which can deal with these subjects,” she told MEPs.
This is not just an issue for the left. Piia-Noora Kauppi, a member of the
Finnish centre-right EPP said, she wanted a “new European supervisory
This interventionist attitude is likely to seep into issues such as
regulation of private equity, hedge funds and attitudes towards sovereign wealth
funds and cross-border takeovers.
As one American lawyer sarcastically put it, “Try doing a hostile deal in
France or Germany right now.”
On the other hand, finance directors might be glad of efforts to prevent
another financial crisis a few years down the line.
Philip Woolfson, a partner at the Brussels office of law firm Steptoe &
Johnson, highlights the proposed Solvency II insurance regime as an example of
“focused and targeted” legislation that could get swifter passage through
Brussels as a result.
But the wider benefit would make the financial system more immune to the next
crash whether that comes from a commodity bubble, the Chinese stock market or
something no one has thought of yet.
As Geithner says, there is no available early warning system. If it existed,
every FD would have one installed on their desk. “What we can do is figure out
how to make the system more resilient to the sort of shock that we will never
have the capacity to anticipate,” he says.