Regulations for banks, financial services firms need fine-tuning
Volker rule lacks clarity in its basic assumptions
Dubai: Players in the banking and financial services sector have learned a lot from their mistakes, with a host of new regulations introduced in the wake of the 2008 global financial crisis making financial systems safer.
However, these numerous new rules require some fine-tuning to make them more effective, according to Randall S. Kroszner, deputy dean for Executive Programmes and the Norman R. Bobins Professor of Economics at University of Chicago Booth School of Business.
“Capital levels [of banks] have improved, and liquidity is much higher, thanks to the new capital rules and better liquidity management tools put in place after the financial crisis,” kroszner told Gulf News in an interview. “On the monitoring of interconnections [within the global financial system], I think that is where we are lagging.”
While it remains hard for an individual bank to deal with risks associated with interconnectedness, Kroszner said the world needs better monitoring of systemwide transactions and the potential systemic risks that they pose.
“Regulators clearly have made a lot of progress in monitoring such risks, but these are not without gaps. So, I do not want to say that there will not be another global financial crisis, but I can say the probability is less,” he said.
Volker conundrum
When President Trump was elected, one of his biggest promises to the finance industry was that he would roll back the Dodd–Frank Wall Street Reform and Consumer Protection Act. The revision and roll back of some the provisions of the Act is still a work in progress.
Apart from the capital rules of Dodd-Frank, Section 619 of the act — popularly known as the Volcker Rule in honour of its advocate, former Federal Reserve Chairman Paul Volcker — was a centrepiece of tougher rules established following the 2007-2009 financial crisis.
The rule is aimed at barring banks from engaging in profit-seeking trades with customer funds. The rule barred short-term proprietary trading of securities, derivatives, commodity futures and options by banks.
The Volker Rule was based on the premise that banks shouldn’t gamble away their federally insured deposits, with proponents arguing that preventing such trading would curtail risky behaviour.
The controversial rule is under revision. The Federal Reserve, the Federal Deposit Insurance Corporation, the Securities and Exchange Commission, the Commodity Futures Trading Commission and the Office of the Comptroller of the Currency all share the responsibility for writing and enforcing the rule. A final version of the rule could be completed as soon as early 2019.
Kroszner said a revision of Volker Rule is a welcome move given the lack of clarity in its basic assumptions that bank failures were a result of proprietary trading.
“It is difficult to find systematic evidence from the global financial crisis that involvement in proprietary trading increased the risk of failure. Major US banks did so primarily because of high exposure to mortgages, not due to proprietary trading,” Kroszner.
Another problem with the Volcker Rule is that there isn’t a clear operational definition of proprietary trading. What can be considered day-to-day operations to one person can be viewed as proprietary trading by another. It is very difficult for regulators to distinguish risky gambling from hedging or market making.