November 26, 2006
Principles based approach to regulation
About a month or so ago, the FSA released a statement encouraging what it calls as a Principle Based Approach to regulation. The FSA is often held in high esteem by other regulators globally as being forward looking to policy and enforcement but many critics argue their new initiative could be extremely complex to install.
To understand the dilemma one must first define what Principles Based Approach to regulation really means and that is best characterized by looking at the opposite. Non Principle Based Regulation. In reality there are two forms of Policy Enforcement that a regulator can entertain, the first which is opted by most regulators, is a set of rules that are created to ensure that regulated entities remain on a narrow road of practice; penalties are outlined for such institutions that decide to or accidentally waver from that path of practice. Each mistake is classified as a breach and can attract damages which are usually financial in nature but on extreme cases involve custodial sentences or license suspensions.
The benefit of such aphorisms is that they are usually transpicuous in nature however difficult such rulemakings are to meet or test. Where the problem lies is that different banks, products, processes and customer groups vary substantially and the regulator then has to use a nebulous gauge on each firm to understand whether the bank is behind or on the line. The concept of Principles Based Approach is top down and goals are set for firms on activities they work with rather than a staircase of rules that has to be ascended to reach the goal. As the FSA puts it, there is an emphasis on outcomes rather than how they are achieved and in many respects a room full of people given the same problem, are likely to go about solving it in alternate ways. While that generates plenty of new practices albeit some unorthodox the argument is then transferred to the result, has the goal actually been met.
Clearly the FSA is looking at a wider set of issues rather than a rule book, their move is also going to encourage a holistic approach to quality in measurement and throughout the full life cycle of a customer interaction. The new approach will also more than likely go against box ticking as such exercises require a rule staircase to be in place for checking against. The downside is that if you are a compliance manager that is not quite sure whether an action is on that line, best practice or perhaps needs investigation, then you are going to need a point of reference. You need to be able to debate specific structures on the grounds of their ability to meet a relatively unfastened desideratum. Then one must ask how is a breach to be enforced, how is it to be defended and what actually is a breach under such a system.
While the advantages of such regulation are clear I suspect that both the FSA and the industry at large are going to need to improve their analytical and creative abilities. Certainly the FSA will have to ensure resources are available for consultation and it will be interesting to see where they draw the line on offering advice. One does question though whether it is more straightforward a test of compliance or whether such predicaments still remain.
Posted by CausalEvents at 04:38 PM
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November 02, 2006
When the FDIC wins do the US banks loose?
In a recent article by Damian Paletta titled Rules on Capital Roil U.S. Bankers, it states that U.S. financial institutions will be at a disadvantage vs international competition because FDIC requires higher capital reserves (at least 5%) than Basel II ... Result is that 20 largest US banks will have competitive disadvantage.
Martin, do you agree with this article?
Yours Sincerely,
Ted.
Ted, it is a sorry state of affairs isn't it and as the FDIC wins the US banking sector seems to loose. Unfortunately the article is correct although what is going on is not so and even if US banks put all their efforts at the accord right NOW they would still be behind the game. That is one argument fuelling the fire of debate and there is a solution to that specific issue but we won't entertain it here. The Basel II accord has three parts and many European banks have been spending recent history working on the biggest components and they are now on the second major objective of Pillar II. US banks however are at a standstill but many of them are in fact more sophisticated than they are being portrayed. The reason for this is that many internationally active US banks have offices in other locales which require them to reach a risk based and intricate perspective of the capital and many of them have been contributing to the QIS exercises in he US. Under current US law however they can't use these analytics and that then leaves them frustrated and impotent.
So what caused this problem, in part the US has so many regulators that non of them really see eye-to-eye on the capital requirements. The Federal Deposit Insurance Corporation, The Office of Thrift Supervision, The Federal Reserve Board, The Comptroller of Currency, the Securities Exchange Commission all have different perspectives, requirements and agendas and, it has seriously made transparent efforts for accord implementation in the US difficult. In some aspects the whole philosophy behind the mandate is being lost. The US has also had to struggle through SOX rulings which is a pre-control compliance exercise and has distracted many financial institutions away from this hot topic.
As stated in the article
A bank's capital, essentially calculated by subtracting liabilities from assets.
This is a naive view of reality because it assumes that liabilities and assets are stationary in value, perhaps only a position in time at best and the author Damian Paletta has done well to capture US outlook in this cliché. Both these balance sheet entities of liabilities and assets are in fact floating, variable, seasonal, influenced by many factors and importantly have a volatility coefficient. The accord in essence embodies that theory, it puts all banks on the path of measuring such factors in combination with those volatility levels and then ties capital against the gap.
Of course the US is trying to dig itself out of this embarrassing position by installing a consistent leverage ratio which puts a floor on the capital requirement but that again is an action that is counterintuitive to the risk based capital maxim itself and the FSA in the UK has rejected support of this leverage ratio. The European regulators are also standing strong and are committed to the agreed capital requirements directive which transposes Basel II capital adequacy rules into European Union Law and will be taken up by nearly all countries in the region. Australia, Japan, South East Asia, India and the Middle East will push forwards with their rulings as they have planned.
What is going to be interesting is to see what comes up next. What are your bets and many of us are wondering how Sheila Bair the chairman of the FDIC is going to react when pressure from the US banking community accelerates. What I am looking forward to is reading all the academic spin doctoring and propaganda that is emanating from these authorities because this is definitely going to become another exercise in duck and weave.
Posted by CausalEvents at 01:13 PM
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