City regulation: the 2008 crisis casts a long shadow

Over-stringent banking regulation fosters the stability of a graveyard. UK Chancellor Jeremy Hunt has embraced that argument, made by his predecessor George Osborne a decade ago. On Friday, he unveiled plans to reform more than 30 measures, including some that Osborne introduced. The package is intended to perk up the financial sector. There are dangers all the same.

Some proposals are undeniably welcome. Loosening the EU-imposed Mifid II restrictions might boost analysts’ coverage. The measure had the unintended consequence of making equity research less economic. That was illustrated by last month’s tie-up between AllianceBernstein’s research division and Société Générale’s cash equities business.

The merits of other proposals are debatable. Take the senior managers regime, which holds top executives to account for failings on their watch. Bankers complain that it makes recruitment harder and an onerous approval process leads to delays. Yet few penalties have been issued.

It would be better to enforce the principle of accountability strictly rather than abandon it.

Likewise, any mooted changes to bank ringfencing should be modest. Refinements that would exempt small retail banks might well boost competition. But the rules are in place to prevent future bailouts. Anything other than minor tweaks would be a mistake.

Thankfully, the government has dropped its plan to create a power to intervene in regulators’ decisions. Politicising regulation would damage stability and competitiveness. Yet it wishes to change the watchdogs’ mandate to include the secondary objective of facilitating international competitiveness and economic growth.

Of course, a well-designed regulatory regime will support economic expansion. But to make competitiveness an explicit goal is wrong. It increases risks of regulatory capture and puts the City watchdogs in a conflicted position.

A worrying precedent exists. The Financial Services Authority, the regulator in charge in the run-up the financial crisis, also had to consider the UK’s competitiveness. What followed was an unforgettable lesson about the downside of this approach.