Reaching consensus on how to fail and how to avoid failure

In the aftermath of the Lehman Brothers collapse, and the manner in which its effects have been felt around the world, international regulators should be focusing their efforts on a bankruptcy code. This is the view of Scotiabank CEO Rick Waugh, who believes that such large, interconnected firms need to be able to fail in an "orderly" way.

"It's an extremely difficult thing to do but, as we saw from Lehman Brothers, it's absolutely necessary that interconnected firms, whether big or small, can fail in an orderly way so as to minimise the damage. I think that attention has to be given to that, rather than to the concept of living wills. This is where the regulators and the other authorities must focus. The US has Chapter 11 and Chapter 7, with their pluses and minuses, and we need something on those lines on an international scale," he says.

A co-ordinated effort

The current level of co-ordination between regulators around the world does not present a hopeful scenario. Only in Europe does there seem to be such a cohesive approach. The recent announcements in the UK first, and France only one day later, of a one-off 50% tax on bank bonuses gives hope that policy-makers across Europe can reach a consensus on regulatory matters. Other countries are expected to follow the UK and France in implementing such measures. It remains to be seen if there are similar levels of consensus for less voter-friendly initiatives.

Despite the need for new policies, Mr Waugh concedes that regulatory rules have never prevented a crisis and that the views of the private sector should also be taken into consideration. As a member of the board of directors of the Institute of International Finance (IIF), and a trustee for the IIF's Principles for Stable Capital Flows in Emerging Markets, Mr Waugh has contributed several recommendations on international regulation.

The manner in which Scotiabank's home country, Canada, has avoided the worst of the global recession could provide regulatory guidance. A year ago, the World Economic Forum declared that the country had the soundest banking system in the world, and in 2009, the International Monetary Fund praised Canadian banks and financial institutions, none of which failed, had to be rescued by the government or came under the systemic pressure that occurred in the US and UK.

Though developments in technology have partly revolutionised the banking business, Mr Waugh says one of the big lessons of this crisis is that one should not rely too heavily on the powers of innovation.

"Banking is one of the oldest businesses in the world, and technology can change the model. But it is management that makes the difference. Innovation has been the buzz word of the past few years, but innovation is not the answer to everything."

New priorities

With the crisis, priorities have changed. Risk management has become the one area chief executives have to get right. "Banks have to make sure that they have a good risk code. Risk management is what counts. Those who do it well are successful, and that's what separates losers from winners. We [at Scotiabank] do it across all sectors, products and countries. It's not a necessary evil, we think it's a competitive advantage. Bankers are not evil, but mistakes were made."

Sound risk practice and international regulation is what the financial sector needs to fully get back on its feet and, more importantly, fulfil its role of contributing to the real economy. Rules on compensation, products and capital requirements need to be balanced. New policies will have to be mindful of the complexity of banks and other financial institutions and of their opinions on what is needed to allow them to grow.

"The big problem is growth," says Mr Waugh. [Banks] have a responsibility; we are the oil for the real economy. Regulation has to allow us to grow - there are only two ways of getting high capital requirements: you pay for it, and that's expensive, or you shrink your bank."