A Witch Hunt in Finance Won't Create a Safer World
Regulators around the world are making good progress toward preventing future bank crises from hurting the global economy. Some of the new rules proposed for individual bankers, however, have more to do with revenge than safety. Unless the aim is to make life so difficult for the world of finance that the banks are forced to shrink -- and, granted, that may be a desirable outcome -- the proposals risk doing more harm than good.
The urge to continue bashing bankers is understandable, if inappropriate. Last week's confirmation that foreign exchange traders conspired to rig currencies even as their banks were being fined for manipulating Libor is clear evidence that the finance industry hasn't learned enough from the credit crisis. Vengeance, though, won't help.
Today, the Parliamentary Commission on Banking Standards, which has been at the forefront of the U.K.'s refurbishment efforts, issued a progress report on its June 2013 recommendations. One of its conclusions makes sense: Bonus payments should automatically end for the executives of any bank that needs a taxpayer bailout. All the work being done to make sure banks maintain adequate capital to avoid that outcome makes this bonus rule especially important.
But the report also says that regulations need to be changed to capture both the individuals who submitted false money-market rates in the Libor scandal and the traders who schemed to distort currency values. According to committee chairman Andrew Tyrie:
Regulation needs to focus on those who can do serious harm to a firm, its customers, or markets. The appalling misconduct in the forex market revealed last week illustrates the importance of this. Traders involved in that misconduct must be included in the new certification regime.
This regime puts the onus on banks to identify the people responsible for each risk-taking function. But it won't work to try to extend accountability all the way down the food chain.
To see why it won't, consider how in 1995, Nick Leeson bankrupted the venerable British institution Barings Plc after losing more than $1 billion. Leeson's trades were supposed to involve minimal risk, exploiting the teeny tiny price differences among equity futures contracts traded on different exchanges in Asia from his Singapore office. Even the most ardent regulator would have been hard-pressed to classify Leeson as posing a systemic threat to Barings prior to his blow-up.
While it seems fair that any and all bank employees should be subject to rules designed to claw back bonus payments that turn out to have been unjustified, it's still impossible to know in advance which new pocket of financial engineering might turn out to cause trouble. Tying the hands of individual traders, before it's clear that their trades are unduly risky, just keeps them from doing their jobs.
If almost everyone within a financial institution is deemed responsible for risk-taking, then no one really carries the can. Designated supervisors should be held accountable for the departments they head, with the promise of sanctions up to and including criminal liability for bad things that might happen on their watch.
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