I’M PUZZLED. I detected a fair degree of fear, uncertainty and even a bit of loathing in the Joint Committee of the European Supervisory Authorities’ (ESA) latest “Report on Risks and Vulnerabilities in the EU Financial System”. Why the puzzlement?
Because beyond the cyclical macro factors that are out there, that fear and uncertainty is based on the self-same, and not-so-cyclical, initiatives that the regulatory machine has itself instigated to save us all from systemic risk and taxpayer bailouts and to open up and diversify channels of finance to the real-economy.
What’s been the impact of the regulatory and supervisory combat manoeuvres that have been centred on the financial sector for several years now? Broadly negative, I’d say. Have policymakers facilitated the creation of an institutional framework that’s better suited to the realities of the New World? Not really. In fact, in some respects, regulatory initiatives are doing little more than painfully and slowly strangling the industry into submission.
But the ESA – an umbrella group of the EBA, EIOPA and ESMA – crows that the alphabet soup of policy and regulatory initiatives – BRRD, CMU, CRD IV/CRR, DGS, EMIR, LCR, MiFID II/MiFIR, NSFR, PRIPS, Solvency II – is “contributing to improving the stability and confidence in the financial system as well as facilitating additional funding channels to the real economy”.
That’s debatable at best, in my view. And by the way I would certainly want our supervisory overlords to have wanted to have done better than “contribute to” stability. But then, confusingly, the supervisors go on to tell us the main risks to market stability have in fact intensified in the past six months and the main risks affecting the financial system have become more entrenched.
Put another way, policy and regulatory initiatives are NOT contributing to improving the stability and confidence in the financial system.
SUPERVISORS HAVE THE gall to question the viability of banks’ business models. “Expectations are that some banks will need to further change their business models towards those which have proved successful, once the regulatory framework has been implemented,” was their priceless comment. Shifting your business model to a successful one? Seriously? That’s where the armies of banking consultants and strategists have clearly been going wrong…
Let’s be clear here: it’s the actions of policymakers, regulators and their central banking brethren that have egregiously distorted financial markets, changed the rules of the game in a way that unnecessarily renders a lot of banking business uneconomic thereby undermining profitability, and forced a lurch for yield that is leading to the creation of asset bubbles. “… investment flows attracted to overheating asset market segments distort funding flows to the real economy and impede future economic prospects,” we’re told. Yup.
“Supervisors should assess and, when needed, challenge the changes to business models of financial institutions to ensure that these changes do not materially impede with the provision of financial services or associated economic growth impulses”, the ESA says. Wrong! They should leave business models to the banks and focus on implementing a supervisory framework that helps rather than hinders the provision of cost-effective and innovative client-focused financial services.
Reading and optimising the interplay between economic, business and monetary cycles is what banks do. But much more perplexing is making sense of the interplay between the cycles and the strategic repositioning banks are being forced to undertake to deal with the regulatory and supervisory cycle the ESA constituents and others have unleashed on an unsuspecting world.
That is just one of many unintended consequences of ill thought-out regulation
SUPERVISORS ALSO HAD the bare-faced audacity to attribute the destruction of bond market liquidity and the withdrawal of market-makers to “structural reasons”. Are they serious? That is just one of many unintended consequences of ill thought-out regulation put in place by people who didn’t have a clue how bond markets worked. Structural my “you know what”.
The ESA says the financial sector is succumbing, among other things, to the effects of low investment demand, economic uncertainty, the global economic slowdown, and the low interest rate environment. Major risks, meanwhile, include low growth and inflation, asset-price volatility, on-balance sheet risk concentration, search-for-yield behaviour exacerbated by potential rebounds; increased concern about IT risks and cyber-attacks and – a mightily odd one here – deterioration in the conduct of business.
On that latter point, supervisors want future misconduct risk included in future stress tests. How on earth do you model future misconduct? Beyond the practicalities, the ESA’s comments suggest a deeply cynical view of the improvements in banks’ internal governance – not to mention the kind of people they still clearly believe inhabit the industry.
And as for that comment about “facilitating additional funding channels to the real economy”, that’s certainly very premature pending the outcome of the CMU (Capital Markets Union) playbook. Supervisors are clearly worried about the credit risk implications of the fund industry becoming active in loan origination. And in its report, it witters on and on about loan participation funds in a way that dramatically flatters their size or importance.
Surely the concerns about direct lending fly in the face of CMU, whose essence is exactly to build institutional funding channels. At the same time as the build-up of direct credit risk worries supervisors, they also talk about non-bank sources complementing traditional bank channels because they’re “expected to provide a valuable stimulus for economic activity in the future”.
Which way round do you want it, guys? I give up.
