Banks might behave responsibly if treated like adults

More regulation. Stricter compliance. Higher capital ratios. Our response to the latest banking mess is predictable enough. Like it was last time. But let’s be honest — prescriptive solutions don’t work.

What to do? As perverse as this sounds, instead of treating our financiers like wayward teenagers, how about we let them be adults? Fewer rules, less intrusion, freedom to run their own lives.

It’s not so radical. A grown-up approach has benefited other industries, despite incredulity at first. In the past even banks have been more sensible when left to their own devices.

An ex-banking colleague once explained to me some parallels with mining. This was a few years after the financial crisis, when some bank compliance and risk teams had already grown more than sixfold and were pushing a tenth of total employees. New regulations were rife.

This miner-turned-analyst said his old industry made these same mistakes after its own existential health and safety crisis. They hired thousands of expert managers, installed safety gear everywhere and signed off everything in quadruplicate. Safety became, in his words, “a religion”. Billions of dollars were spent but results were below par. Everyone was baffled. What was the problem? In came a consultant from DuPont, chosen because of its enviable safety record.

Amazingly, the US chemical company had as few guard rails as it did procedures and manuals. Rather it focused on behaviour. Safety was integral to its culture and driven into the brain of every hire. There were no excuses. What is more, management walked the talk and understood that operating standards must come from the floor. This made sense to us, said my ex-colleague. Diggers know best where the risks are, not auditors.

Finance needs a DuPont epiphany. Instead, banks are overwhelmed by regulations which don’t make them safer. The Depression-era Glass-Steagall act was 37 pages. Dodd-Frank legislation after the last crisis was 2,300 — with 10 times more published by agencies to “help” with implementation.

Imagine if the million hours of annual regulatory training reported by some lenders were spent analysing risk. Bankers instead rush to complete endless online compliance modules, lest their bonuses are docked. Half asleep, mouse clicking furiously, my record is seven minutes for a half-hour lesson. (Hot tip: switch to transcript mode to bypass the unforwardable videos.)

Until five decades ago, spending all one’s time worrying about clients and capital was exactly what bankers used to do — with little or no interference in who they lent to, or how many assets they had to hold against their loans.

Finance was arguably better off because of it, as Forrest Capie and Geoffrey Wood contend in an Institute of Economics Affairs paper on the UK experience. They looked at the behaviour of the country’s banks after most regulations were stripped away during the 19th century.

British lenders were left to determine their own capital ratios during the first world war, depression and second world war. They did this with aplomb. Both sides of their balance sheets were adjusted up and down to suit the conditions and it was a period of remarkable stability (at least from a banking perspective).

Lenders were sometimes even prevented from being more conservative with their capital ratios, for example in the 1950s, when the government was in rebuild mode and didn’t want too much money ending up in the private sector. In the next decade, banks raised them of their own accord.

This is no inherently reckless sector, then. Without capital requirements and state guarantees, UK banks went for more than a century without a crisis until the 1970s. Then everything changed: never were they trusted to look after their pennies again.

Successive Basel accords, from 1988 (30 pages) to 2010 (Basel III, almost 1,000 pages), have regulated in ever more detail how to define and value bank assets and liabilities.

Dismissed like children, bankers understandably felt they had nothing left to do except play. Gaming “regulatory capital” numbers was pointless but fun. So too off-balance sheet hide-and-seek. Synthetic derivatives paid for lots of sweets.

Then came the financial crisis. So yet more rules were imposed and bankers were forced to write them out a thousand times. Which didn’t leave Credit Suisse much time to think about the quality of its clients or Silicon Valley Bank its interest rate risk.

I am not saying bankers are angels. But it’s time to treat them like adults so they behave like adults.

stuart.kirk@ft.com