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Even though the world financial crisis was brought on by a decade of systemically reckless government policies and programs -- monetary policy, Fannie Mae, and now Dubai World -- one of the great political fads among governments these days is to take a run at banking reform. On a global scale, this is usually portrayed as a grand co-ordinated scheme to avoid "systemic risk" by making sure the financial system is in the future safe from perils created by overpaid bankers running amok on the next incarnation of default swaps. The bigger the banks, the bigger the regulatory fix needed, to the point where large financial institutions, including insurance companies, are to be asked to prepare "living wills."
Nobody has a clue as to what a living will might look like, even though central bankers and finance ministers from the G20 regularly tout their importance. Bank of Canada Governor Mark Carney said recently that, "Banks themselves should develop 'living wills,' or plans to unwind in an orderly fashion if they were to fail." How's that for a mandatory bank strategy for the new era: Plan for failure!
The way things are going, such plans might be needed. The concept of living wills for banks, with all the regulatory paraphernalia they imply, looks more like a plan for living death certificates. Banks will be asked to adopt new capital and liquidity controls, with large institutions assigned special status as "too big to fail," in which case they will be listed by the G20's Financial Stability Board as targets of systemic risk regulation and living will demands.
Beyond such top level concerns as capital ratios and what to do in the event of systemic failure, the banking industry is being advised by the ubiquitous corporate strategic planning industry to look upon banking as the organizational equivalent of
the sewage system. In a recent report, Booz & Co's leading financial services advisor, Vanessa Wallace, told Booz's international banking clients to cheerfully prepare for permanent entanglement with governments.
It is highly likely that, by 2011 or so, the regulatory landscape in banking will more closely resemble that of public utilities. Like a water or electric power company, a bank will be seen as an entity that provides society with a product or service so essential that it essentially cannot be left to market forces alone. Utilities tend to face a high regulatory burden, which dictates many elements of their pricing and operations, and often inhibits their levels of innovation and experimentation.
The Booz analysis is essentially a non-judgmental endorsement of all the conventional wisdom on the need for new regulation -- system risk, too big to fail, markets not always efficient, misaligned compensation schemes -- and fresh calls for banks to become more responsive to stakeholders and to eliminate "cult of the leader" syndromes. In other words, turn banks into public utilities -- the national dream of Canada's New Democratic Party for more than half a century.
No wonder Royal Bank of Canada CEO Gord Nixon told analysts last week that bank executives should prepare to spend most of the rest of their careers coping with living wills and other regulatory cobwebs. "In the next five years, leaders in financial services will be defined by their ability to successfully manage regulatory reform."
When bankers spend the bulk of their time fending off or untangling regulatory intervention at the national and international level, the burden of such distraction can only fall on the rest of us as customers and investors. We can all look forward to less lending, higher risk premia, lower profits and smaller dividends. The signs are already there. Said Mr. Nixon: "Navigating the regulatory environment over the next few years is going to be tough, and we will have to go into that with a fortress position."
Roughly translated, that means banks are going to have to run their lending and acquisition desks with an eye on new extreme capital and liquidity controls imposed by regulators who believe that financial institutions are inherently prone to out-of-control manias and the creation of credit bubbles. The Booz paper enthusiastically looks forward to demands for greater transparency from investors, governments, customers and communities.
Warnings abound these days that economic growth will be slower in the future. If banks are run as utilities, slow growth is a sure bet. Subjecting banks to living wills, extreme capital requirements, and new intervention can only bog them down in caution, red tape and inefficiency. The burden is all the greater because the effort is wasted on the banks. What they really need protection from is reckless government policies -- such as zero interest rates, rampaging deficits, major government economic interventions in autos and other sectors, and the next Dubai World-like default on sovereign debt.
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