"In theory there is no difference between theory and practice. In practice there is"

There are many views and opinions behind the rationale of bank regulation, there are many thoughts including the free banking view shared by economists such as Friedrich Hayek, Kevin Dowd and Lawrence H White.  Their belief is that the free market mechanism met with the competition associated will lead banks to behave in a prudent manner, hence removing the need for regulation.  They believe bank instability is due the governments monopoly note issue and the ever reliance on the lender of last resort facility.  A “lender of last resort” is a facility set up to provide funds for banks if they come into difficulty, which in turn will alter the actions of the bank as they will have a guarantee of being bailed out.. The above mentioned economists are known to be the forefathers of the “free banking school” and whilst their views have sparked much debate they are very much in the minority; Hickson and Turner (2004) found that free banking only appeared to work in times of “narrow legal restrictions” and they argued that bank regulation was an efficient solution in areas such as over issue and risky investments. 

There are many arguments for the reason for regulating banks, one of these includes the Systemic risk view.  The main reasoning here is that if one bank falls, the negative externality effect throughout could have an adverse effect on the system as whole through issues such inter-bank lending.  The asymmetry of information does not allow for depositors to distinguish between good and bad banks whereas some form of regulator will have access to private information and can set up practices of discipline and prevention tactics.   

There are indeed other views regarding the need for bank regulation; bank regulation is a relatively new concept, in 1878 the Bank of Glasgow collapsed under a system of no regulation, which in turn benefited its competitors.  This issue points us in the direction that one bank falling could have a positive impact on the economy however the heavy reliance on competitors in modern day finance can be seen as a symptom of structural weakness within the system.  However, in my opinion I feel that an unregulated system is not suitable in the modern day financial world.  With the media spotlight ever increasing appropriate actions met with stringent regulation will increase confidence within the system which in turn will allow any system to succeed under the correct market conditions. 

Next week I will talk about who should regulate the banks and give my own opinions on the current economic crisis.

Thanks for Reading

Take Care

PN

References

Title- Yogi Berra

C. R. Hickson & J. D. Turner, 2004. "Free banking and the stability of early joint-stock banking," Cambridge Journal of Economics, Oxford University Press, vol. 28(6), pages 903-919, November

Do as i say, Not as i do!

Over the last week I have been investigating the actions (or lack of!) of the FSA over the past decade, I have read a number of official publications published by the FSA and my conclusions from reading these leave me as bewildered to the issue than I was before I started.  The article I am going to talk about is the FSA’s publication on the collapse of RBS, “The Failure of the Royal Bank of Scotland” December 2011, www.fsa.gov.uk/pubs/other/rbs.pdf.  

It is well documented the rise and fall of the RBS, whether it be the actions of Sir Fred Goodwin or the acquisition of ABN AMRO, it is clear that much bitterness is held against said collapse and the generalised populous, as tax payers, feel hard done by.  It is clear from media coverage that there are a vast array of people who are held accountable for the current economic crisis, and from reading the above publication it is little wonder why. 

The FSA’s publication attempts to answer a varying number of questions in a long winded and tiresome 452 page statement (the cynic in me believes it is that long to stop people reading it!).  However if you dig deeper into the article it does find a number of interesting issues; the FSA believe that there are a number of key reasons why RBS failed, which in turn led to the current economic crisis, two of which are shown below. 

They firstly believe that the regulations that were in place at the time regarding capital were insufficient, this created a culture of inadequacy of capital within banks, thus combined with a heavy reliance of short term funds from wholesale markets led to an exposed system, the report also states that the regulators failed to understand the consequences of such a systemic fragility and they state that it is “central to the origins of the crisis”.  The FSA here state that the regulations under estimated the need for capital, a problem which they claim to be rectified.

The second issue is that of the acquisition of ABN AMRO. This acquisition increased RBS’s exposure to risky asset categories and reduced an already  low capital ratio.  The FSA state that this acquisition was done without due diligence and the risks associated were not carefully considered.  They also admit that their level of regulation was inadequate and provided insufficient challenge to the issue, they do however state that the blame for such an event occurring must lie with RBS….

In my opinion they are almost passing the blame here and turning it away from themselves.  If your role within an economy is, to regulate important decisions that have never-ending consequences for the rest of the financial world,  do just that and not put the blame back on the company.  It is almost like leaving the front door of your house open, then blaming the police for your house getting burgled.

I am not for one second stating that RBS are in no way accountable for what happened, of course they are, but the attitude of the FSA in this article is apparent of a culture that has been created, one of “passing the buck”.  I feel that this brief insight into the FSA’s dealings with RBS has painted a picture of an authority that were poorly run, and through their own admission, provided an inadequate service.   Next week I am going to look at the theory behind financial regulation and whether or not is it is necessary in modern day financial industries.

Thanks for Reading

Take Care

PN


PS Below is a link to FSA's chairman Adair Turner's recent interview on BBC.
http://www.bbc.co.uk/news/business-16135506

Don't hate the player, hate the game...

Directed towards Ed Miliband in the House of Commons, David Cameron recently said “if you are going to jump on a bandwagon, make sure it’s still moving”, this was in response to the Labour leaders constant criticism of the actions of bankers, adding to the “bash the banker” vendetta apparent in recent media coverage.  Although it cannot be ignored the rash actions of a few have indeed contributed in part to the current economic crisis, I am under the persuasion that it is not the individuals who are accountable, but it is those who supposedly regulate these industries.  In the United Kingdom, during the past decade, this responsibility has been down to the Financial Services Authority (FSA), their missions include regulating four broad areas namely; market confidence, financial stability, consumer protection and the reduction of financial crime.  Throughout the coming weeks I am going to investigate whether or not the FSA acted in line with their above missions, I am also going to take a step back and examine the reasoning behind financial regulation and determine its necessity in modern day financial markets, finally I will provide my own insights to the current crisis provide you my opinion on who or what is to blame!

Thanks for reading.

Take Care

PN