Increased banking regulation could do more harm than good  

By: Laurie Dippenaar (Extract from the 2015 FirstRand Annual Report)

Increasing regulation continues to cast an ominous shadow over the banking industry worldwide. I spent quite a lot of time on the topic in my report last year and my argument was that banks, in the main, have brought the burden of new regulation on themselves.

I expressed disappointment that it had re-emerged as the key concern for senior executives in various surveys last year and the concern appears even more elevated this year.

Recently the tax and management consultancy PwC, surveyed 175 banking and capital markets chief executives in 54 countries. Over-regulation was a concern for 89% of them, up from 80% previously, while a massive 87% of chief executives thought that regulation would continue to have a disruptive effect in the next five years. Five years! That will take us to 2020, 12 years on from the global financial crisis. It makes you wonder what the real agenda is.

There is a very strong view that banks are useful political “footballs” as they are enormous institutions, systemically important, are still to this day uncovering illegal practices and can appear unfeeling and sinister to their customers. So they remain easy targets, particularly for the populist politician. In certain cases I am beginning to think that regulators have lost sight of their mandates, and that some proposed changes, whilst superficially ticking “protect the customer” boxes, have serious potential for systemic risk in the long run.

It is important that regulators steer clear of trying to please their political masters. Using regulation to win the hearts and minds of voters is one thing but damaging the economy is quite another. Politicians love to use the phrase “ensuring a safer system” but when does that tip over into “ineffective and unprofitable banks and disenfranchised customers”? The natural constraints and incentives of the free market system also play an important role.

Banks obviously won’t be successful if they don’t treat customers fairly and if they aren’t careful and wise in loan and investment policies and decisions.

What makes this subject so interesting is the ongoing wave of regulation in the USA, which many commentators believe places burdens on financial institutions that not only impact the world and national markets, but also individual citizens, through consumer regulations so strict that the cost to implement will eventually price the consumer out of most financial institutions. Additionally, regulatory reporting and compliance provisions are costly. In an article for the Wall street Journal, Frank Keating tries to distill this cost into a useful comparative.

“Consider a conversation I had recently with a banker in Nebraska. For the first time, he said, his bank now devotes more work hours to compliance than to lending. Specifically, he has 1.2 employees on compliance for every one employee focused on lending and bringing in business.

Imagine a manufacturing company that deployed more than half of its work force as Occupational Health and Safety Administration compliance officers. Such a company would be unable to grow, let alone contribute to broader economic growth.”

This analogy resonates with me. Yes, regulation to stop excessive risk taking, mitigating abuse or price fixing and ensuring that depositors money is not frittered away on investment banking deals all make headlines and keep politicians looking honest and regulators looking prudent and proactive. However, the kind of regulation the banker in Nebraska is talking about is extremely worrying as it makes organisations that need to become more efficient (so that they can pass on cost benefits of technology and innovation to customers) become more inefficient. Another quote from the Wall Street Journal:

“In the three decades before the Dodd-Frank bank regulation law passed in 2010, an average of more than 100 new banks opened each year. In the five years since 2010, exactly one new bank has opened — a small bank in Bird-in-Hand, Pennsylvania, serving the Amish community. Going from more than 100 new banks each year to only one new bank in five years is an amazing decline. Bankers say the drought is a sign of new regulatory requirements in the wake of the financial crisis, which are boosting expenses and discouraging potential startups from even trying.”

Of course this is the USA and a large developed market, probably the most regulated market in the world, but still 100 to 1 in five years is pretty depressing. Also, it’s important to note that most emerging markets are following global regulators, so even if you run a bank, or you want to start a bank in a growing economy you will end up being bad for customers.

It’s an interesting topic in the South African context too, as the banks here face up to a world of ever increasing regulation. Some of it we welcome as it seeks to create level playing fields, eradicate systemic abuse (the use of garnishee orders comes to mind) and enforce caps on credit life where some lenders were making ridiculous profits at customers’ expense. However, the sense of some regulations is less clear, such as the recent dti proposals to significantly reduce caps on unsecured lending. Whilst on the surface this proposal aims to reduce the risk of unsustainable (and in some cases unpayable) interest rates, the balance must be struck with regards availability of credit, appropriately risk adjusted.

This is very important in a country where millions of people need to borrow to live and build their future NAV. It also has very negative connotations for the resurrection of the ABIL good bank which we believe has a real role to play in economic activity going forward.

What is clear is that increasing regulation is here to stay, but what we need to guard against is over-regulation which can reduce bank flexibility to meet the unique needs of customers, particularly where common sense is replaced by complex rules. Fear of violating regulations and potential lawsuits leads to fewer loans, ultimately hurting customers and their communities.

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