Heavy-handed regulation is counterproductive and could make bank failures more likely.

The danger is that regulators will end up running the banks. As they failed to spot the impending crisis in 2009, it seems questionable that they will do a better job than the bankers.

The UK regulator, the Financial Conduct Authority, has just handed out a record £28m ($45m) fine to Lloyds for “serious failings” in its sales practices. This concerns the bonus structure in place up until 2010 for the selling of financial products, such as savings accounts, to retail customers.

For most bankers the idea of limitations on traders’ multi-million dollar bonuses seems reasonable, but the idea of a regulator micromanaging the incentives scheme for the entire sales forces takes regulation to a whole new, and possibly unhealthy, level.

Further evidence of this comes with the news that the other twin peak of UK regulation, the Prudential Regulation Authority, has forced Standard Chartered’s highly respected group finance director Richard Meddings to relinquish oversight of the bank’s risk management. Chief risk officer Richard Goulding will now report directly to the CEO Peter Sands.

The implication seems to be that the CFO is so motivated by pure profit that he or she cannot take clear headed decisions about risk. Is the CEO any less conflicted? Given Standard Chartered’s admirable record in steering its way through the crisis in good shape, the trend towards a 'one size fits all' model of governance is probably misconstrued.

Regulatory micromanagement is steadily becoming part of the new rules such that banks will eventually have nowhere to hide. In theory that may seem like a good thing. In practise it could make failures more likely.

During the crisis mark-to-market accounting standards had the impact of crystallising trading losses and so preventing banks from working them out over time. But some banks did save themselves from huge immediate losses by shunting trading assets into the banking book, which allowed them to be accounted for differently.

In the Basel Committee on Banking Supervision’s (BCBS) review of the trading book, the boundaries between the banking book and the trading book are proposed to  be much more clearly drawn and so in the next crisis this will not be possible. Result: stricken banks will fail faster.

At the same time, as the rules have been tightened to the point of being almost unworkable, the big underlying cause of financial crises – vested political interests – has gone largely unchecked.

In an article in Foreign Affairs, two professors – Charles Calomiris and Stephen Haber – point to the role played by the US Congress under the lobbying influence of urban activist organisations to push Freddie Mac and Fannie Mae to repurchase mortgages made to low-income households from the banks.

“The government mandates on Fannie and Freddie were not vague statements of intent. They were specific targets, and in order to meet them, Fannie and Freddie had little choice but to weaken their underwriting standards by permitting higher leverage, weaker mortgage documentation, and lower borrower credit scores,” write the professors.

In the UK new Bank of England governor Mark Carney says he can advise but has no power to curb or stop the government’s Help to Buy scheme, which some critics blame for causing a housing price bubble. This means that for all the rule changes and micromanagement, a government embarking on a populist but ill-fated housing policy is beyond the scrutiny of the regulators. Without plugging this hole no amount of rule making can prevent the next financial crisis.

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