US President Donald Trump made his intentions on financial regulation clear from the very start of his administration. He issued an executive order requiring that, for every new regulation imposed, at least two should be targeted for repeal. No such deregulatory zeal is evident in Europe.
The Economic Growth, Regulatory Relief, and Consumer Protection Act, signed by Trump in May 2018, has, in practice, emphasized the second part of its title over the third. According to a set of regulatory principles issued by the administration, regulators must consider the competitiveness of US firms and advance American interests in international financial forums. The Treasury was instructed to produce four reports, covering banks, capital markets, asset management and insurance, and non-banks and fintech, to show how the principles could be realized through a variety of deregulatory initiatives. All four reports have now been issued.
For a time, this political activity seemed to be rhetorical, with few significant changes to the regime affecting big banks. The early focus was on relieving smaller lenders of some of the burdens of reporting and capital regulation – rules that arguably were not well designed for them.
But now there are signs that the initiative is gathering momentum. New leadership has been introduced at the main regulatory bodies, and those leaders, at the Securities and Exchange Commission (SEC), the Federal Reserve, the Federal Deposit Insurance Corporation (FDIC), and other agencies are competing to show how they can best demonstrate their commitment to deregulation. Those who monitor these regulators’ activities closely say that the number of new regulations being introduced is now at a 40-year low, and firms’ compliance costs are falling for the first time since the 2008 financial crisis.
It is also evident that big firms as well as small are beginning to benefit. The Financial Stability Oversight Council, the overarching body chaired by the Treasury, has decided to de-designate all of the big insurance firms previously considered to be systemically significant, and which therefore required a capital supplement.
In some ways, this is not surprising. It is now more than a decade since the financial system blew up and cratered the global economy. Memories fade, and the regulatory pendulum begins to swing back. A recent IMF working paper on regulatory cycles examines a series of past episodes, from the South Sea Bubble to the subprime crisis, and shows how these booms and busts were “amplified by political regulatory stimuli.” Credit subsidies of various kinds, together with light regulation, fueled the booms, while the busts were followed by regulations aimed at slamming shut and bolting all stable doors through which the horses had already escaped.
Those post-crisis regulations, which may be an overreaction, often do not survive; in some cases, do not deserve to. The Bubble Act of 1720 remained in place for over a hundred years and constrained the development of joint stock companies, with a damaging effect on economic growth.
So, some rowing back from post-crisis regulation may perhaps be expected. But it needs to be implemented with the greatest care, and even the most enthusiastic investment bankers would not argue for a return to the low-capital and low-liquidity regime in place in 2007.
What is noteworthy in this cycle, however, is that while the impact of the crisis was fairly similar in most developed countries (with some idiosyncratic features in each case), the regulatory pendulum is not swinging back in the same way outside the United States.
In the United Kingdom, banks are only this year implementing new ring-fencing rules enforcing a separation of their investment banking activities from their retail and commercial activities, at a time when the analogous Volcker Rule in the US (which in any case is far less constraining) is being watered down. A new senior managers regime is being introduced in London for banks and insurance companies, tightening up the requirements on directors. In the eurozone, the banking union similarly remains in a re-regulation phase, both centrally and country by country. And earlier this month, the French authorities imposed a new countercyclical buffer – a capital surcharge – at a time when the economy is slowing sharply (if it is not already in recession).
In Europe, there is evidently little or no political appetite for deregulation of the financial sector. European right-wing populists are as hostile to bankers as their left-wing counterparts. In this area, the Trump agenda finds no takers at all.
The markets have noticed this transatlantic difference in regulatory cycles. Most European banks are trading at well below their book value, in some cases below 50%, while US bank valuations have recovered. That no doubt partly reflects the US and European economies’ relative growth rates, and their different interest-rate curves, but expectations of future regulatory requirements are also part of the mix.
And yet this misalignment of regulatory cycles matters less than one might think, because US and European retail and commercial banks do not compete very directly. Global banks – those beasts with a presence in all major markets – are as out of fashion as flared trousers. But there is head-to-head competition in investment banking, with US banks’ market share in Europe rising in the last decade.
Perhaps different societal choices are implicitly being made. European governments have seemingly concluded that hosting large, risky, and volatile financial firms and markets is not worth it, while the US administration still regards the financial sector as a comparative advantage for New York. We will not know for a while yet which side has made the wiser choice.
Howard Davies is chairman of the Royal Bank of Scotland.
Copyright: Project Syndicate, 2019. www.project-syndicate.org