Treading a fine line

Speaking to the press last week, Colm Kelleher, chairman of Morgan Stanley International, proclaimed financial markets had returned to a strong bill of health since 2008, with successful development of regulatory regimes such as Basel III. But, others find room to disagree.

“We are now in a much safer place,” suggested Kelleher, at the press reception in London. Kelleher should know. He was CFO of the firm when Lehman Bothers collapsed and Merrill Lynch sold itself to Bank of America, leaving the two remaining pure US investment banks – Morgan Stanley and Goldman Sachs – to take public funds and adopt deposit-taking status, albeit temporarily and under duress.

In the intervening five years, all major jurisdictions have radically altered how they regulate their banking and finance industries. Temporary measures and new laws have been introduced, while scrutiny of financial market activity has intensified, not just by regulators, but also clients, shareholders, politicians, the media and the public.

One lynchpin of regulatory reform and the instrument of choice for many governments in reducing risk in the financial sector, has been the Basel Committee on Banking Supervision’s updated capital adequacy framework, Basel III. But, there remains widespread division whether these new Basel rules have effectively reduced risk.

John Kay, visiting professor of economics at the London School of Economics (LSE), and chair of the Review of UK Equity Markets and Long-Term Decision-Making, which reported to the UK government last year, believes Basel III falls well short of the mark.

Speaking recently about financial markets regulation, Kay labelled the latest iteration of Basel rules as “misconceived” as a mechanism for reducing risk and insisted that regulators efforts to reform the finance sector have been “extensive and intrusive, but ineffective in achieving [their] underlying objectives”.

In particular, Kay believes retail and investment banking businesses are too different culturally to be managed together.

But, attacks on Basel III for being both too timid and too severe could indicate that regulators have got it about right in terms of restricting risk taking by the banks without having too damaging effect on the real economy, according to Nicolas Véron, senior fellow at Brussels-based economics think-tank Bruegel and visiting fellow at the Peterson Institute for International Economics in Washington.

Speaking recently, Véron argued that Basel III is “neither excessive nor radical” and suggests regulators are proceeding cautiously.

In the view of Morgan Stanley’s Kelleher, regulatory reform is welcome in principle. But the volume, complexity and inconsistencies in the new rules are leaving banks unsure how to respond. This complexity, agrees Kay, continues to be a source of risk. “The problem is not that banks are too big too fail, it is rather that they are too complex to fail,” he said.