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Constraining discretion in bank regulation

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According to Andy Haldane from the Bank of England, making greater use of simple, prudent regulatory metrics could restore faith, hope and clarity to the financial system to the benefit of banks, investors and regulators alike.

Speech
Andy Haldane, Bank of England
6 June 2013
Sources: Bank of England and Bank for International Settlements

>  Speech given at the Federal Reserve Bank of Atlanta Conference on “Maintaining financial stability: holding a tiger by the tail(s)”, Federal Reserve Bank of Atlanta, 9 April 2013

From the introduction:

Since the mid-1990s, banking regulators globally have allowed banks the discretion to use their own models to calculate capital needs. Most large banks today use these models to scale their regulatory capital. In doing so they are, in essence, marking their own exams. This self-regulatory shift was made with the best of intentions. Yet its consequences have been predictable. Self-assessment has created incentives to shade reported capital ratios. As elsewhere, a regulatory regime of constrained discretion has given way to one with too much unconstrained indiscretion. This calls for regulatory repair. Without change, the current regulatory system risks suffering reputational damage. Fortunately, there are early signs that regulatory change is afoot to place tighter constraints on this (in)discretion.

To understand how we ended up here, it is useful to explore the historical contours of the regulatory debate. This is a history in roughly four chapters…

Conclusion:

Over the course of the past 20 years, banking regulation has edged in a self-regulatory direction for understandable, but self-defeating, reasons. The regulatory regime has tilted from constrained discretion to unconstrained indiscretion. It will be a long journey home, but that journey has started. Making greater use of simple, prudent regulatory metrics could restore faith, hope and clarity to the financial system to the benefit of banks, investors and regulators alike.

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