This is how a race to the bottom can start. In Washington, President Donald Trump has vowed to roll back the financial regulations passed after the 2008 crisis. In London, Prime Minister Theresa May, facing a possible exodus of bankers as Britain quits the European Union, has said she might fight any “punitive” trade measures from the EU with tax cuts or policy changes to attract investors and companies. At the same time, some EU member states could consider relaxed rules to entice London-based firms. In Brussels, Europe’s top regulators are angling to soften the latest round of international banking standards.
It wasn’t supposed to go like this. Until last year’s tectonic political shifts in the U.S. and U.K., financial regulators had been moving toward tougher rule-making and greater coordination. They’ve tried to stamp out “regulatory arbitrage”—banks moving their riskiest businesses to those jurisdictions with the weakest standards. The lesson of the financial panics of the 21st century, from Lehman Brothers to the European debt crisis, was that crises aren’t confined by national borders.
Regulators have required large global banks to hold more capital, financing more of their lending from equity rather than debt, so they’re better able to weather losses. Lenders are subjected to regular stress tests to assess their risk of failure.
But as finance ministers, central bankers, and industry executives convened in Washington in late April for annual spring meetings on the global economy, the conversation was a bit different. Although a regulatory rollback hasn’t happened yet and could take years if it did, Mark Carney, head of the Financial Stability Board of global regulators created after the crisis, warned in an April 20 speech against “reform fatigue” that could leave some regulatory efforts unfinished. “The global financial system is at a fork in the road,” said Carney, who is also governor of the Bank of England. He pointed to “nascent risks that, if left unchecked, could threaten the progress made.”
Since the U.S. election, financial stocks have rallied about 20 percent, in part on investors’ hopes for lighter regulations. Jamie Dimon, chief executive officer of JPMorgan Chase & Co., has written that the financial system is safer post-crisis but that banks, anxious about increased regulator scrutiny, now have too much capital, constraining lending. Anat Admati, a Stanford finance professor, counters that “no regulation stops banks from using their profits, or raising equity from investors, to make worthy loans.”
In a few instances some regulators have conceded there’s room to tweak the U.S. regulations. Daniel Tarullo, who spearheaded many of the most important restrictions at the Federal Reserve before he stepped down in April, said some requirements could be softened for smaller banks. But Trump has been pushing for even bigger changes. On April 21, the president ordered Secretary of the Treasury Steven Mnuchin to review regulations meant to help authorities wind down a failing bank, as well as rules for designating some nonbank financial institutions as systemically important and therefore subject to additional restrictions.
That worries policymakers outside the U.S. “The big question on which the Europeans are awaiting clarity is whether the U.S. really goes its own way on questions as pivotal as orderly resolution” of failing firms, says Karen Shaw Petrou, managing partner at Federal Financial Analytics Inc. in Washington.
At the Basel Committee on Banking Supervision, a group of regulators has worked toward international agreements on capital standards since the 1980s. A pending revision to the rule books is supposed to limit banks’ ability to use their internal risk-assessment methods to determine whether they have enough capital.
European regulators and politicians have argued that proposed changes are too tough on their countries’ lenders. The U.S. has so far taken a harder line than the Europeans. The latest Basel rules were supposed to be completed at the beginning of the year, but they’re on hold while European politicians and regulators wait to see whether Trump and his slate of regulators shift direction.
The EU is working to fine-tune regulations to make them more “growth-friendly,” said Valdis Dombrovskis, the EU’s financial-services chief, in an April 20 speech in Washington. Still, he said the bloc isn’t willing to lower standards for keeping banks safe. “We count on the U.S. to stand by the same principle,” he said.
European officials are also looking inward as they contend with Britain’s vote to exit the EU. May has joined other lawmakers in suggesting regulatory changes might be pursued post-Brexit. Intercontinental Exchange Inc., one of the world’s biggest trading platforms, has said Brexit offers the U.K. an opportunity to review misguided rules from Brussels. Lawyers at Shearman & Sterling LLP in London have called on policymakers to consider using Brexit to achieve a “market-friendly regulatory framework.”
Countries in the EU, competing to attract business as European finance reorganizes after Brexit, are asking whether regulations might be used as an incentive. Ireland already has complained to the European Commission, the EU’s executive arm in Brussels, that other countries are offering looser rules as part of a “dangerous competition” for business.
The European Securities and Markets Authority, which seeks to coordinate standards across the EU, is concerned about what could happen if national regulators across Europe allow U.K. firms to set up offices in their countries while keeping the main part of their business in London, so that European regulators might not have proper oversight. At the European Central Bank, regulators have warned about a loophole that could hurt their ability to oversee markets if banks relocate businesses from the U.K.: The ECB doesn’t supervise branches and brokerage units of foreign lenders. Those are left to national regulators.
The ECB said it needs to consolidate oversight to prevent banks from playing national supervisors off one another. “We will be cautious of regulatory and supervisory arbitrage,” ECB executive board member Sabine Lautenschlaeger has said. “And we will not take part in a race to the bottom in that regard.”
The bottom line: After a series of financial crises, regulators in the U.S. and Europe got tougher. Then came two very big elections.