Lessons from history show self-regulation to be the best kind of control

Every scandal or crisis in financial markets yields a response of more bureaucratic regulation and more boxes to tick. The consequences are increased costs, poorer regulation and reduced competition.
The main focus of policy discussion is further regulation of the banking system. But, instead of binding banks up with red tape, we should encourage them to regulate their own behaviour. At the moment, self-regulation does not work because of the way the state underwrites risk in the banking system. When banks take risks, they gain from the upside but the taxpayer is often left with the costs of bail-outs when things go wrong. The focus must be to make sure banks bear the costs of the risks they underwrite.
A first step should be a risk-based deposit insurance system where banks pay premiums based on the risks they take. There should be much better mechanisms for an orderly winding up of failed banks and complex financial institutions. In addition, banks could issue debt capital which would automatically become equity capital if the institution became insolvent. If these steps were taken there could be a considerable improvement in market discipline without the need for complex regulation.
History provides grounds for optimism that deregulation could work. Before the Government regulated the banking system and underwrote deposits, banks held much more capital. They also had special mechanisms such as “double liability” for shareholders to signal to customers their conservatism. It is incentives that matter, not rules.
The EU agenda of sending regulatory tentacles farther out into the financial system in its moves to regulate hedge funds is mistaken. It is true that those banks that have deposit insurance will need some focused and coherent supervision even if the suggestions above are followed. But those banks, and other financial institutions, that do not have deposit insurance can be left alone by the regulators.
An Institute of Economic Affairs study, Does Britain Need a Financial Regulator? shows state regulation crowds out more effective self-regulation and that state regulation has now become an industry in itself.
The study focuses on investment markets and stock exchanges – but there are lessons for the banking sector too. The historical development of exchanges was remarkable. From the earliest days more than 200 years ago they developed mechanisms of self-regulation to ensure that a member’s word would really be his bond. They also evolved excellent systems for dealing with problems such as conflicts of interest. By the late 20th century there were problems which required some attention. But the advent of statutory regulation in 1986 has done more harm than good. Many of the things that are now dealt with by the EU or the Financial Services Authority can be dealt with by stock exchanges themselves.
Why did the market develop such effective self-regulatory mechanisms? As ever it is our friend “self interest” at work. While it is often said that market-generated regulation will lead to a “race to the bottom” this assertion cannot be justified. Companies want to achieve the lowest cost of capital. A company wishes to have its shares traded on an exchange so that it can raise capital cheaply – the academic evidence on this is clear. An exchange, in turn, needs investors. As such, the exchange that will get most business is not the one that regulates the least but the one that regulates the best.
Across all these fields, the message is the same. There is no point trying to avoid scandals and crises by having bureaucrats writing more and more rules. The key is a financial system where prudent behaviour runs with the grain of self interest. And we must not crowd out the private regulatory bodies that propelled the creation of sophisticated financial systems in the UK. The stock exchanges of the 19th and 20th centuries were all part of the “Big Society”. If the Government really wants the Big Society to flourish again in this sector, it needs to roll back financial regulation, not draft more of it.
Prof Philip Booth is editorial director, Institute of Economic Affairs, and professor of insurance and risk management, Cass Business School
Five Filters featured article: “Peace Envoy” Blair Gets an Easy Ride in the Independent. Available tools: PDF Newspaper, Full Text RSS, Term Extraction.

OFT targets web abuse of customer data

The Office of Fair Trading has called for a clampdown on online retailers who
gather data on potential customers’ web activities and use it to target them
with advertising and to determine the price charged for goods.

Online behavioural advertising typically uses information collected through
“cookies”, files which are placed on a user’s computer after their first
visit to the website.

Companies might use data collected on a person’s location, likely income,
buying preferences or age to offer them prices that differ to those offered
to other customers.

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New banking rules are fatally flawed

November should mark a brighter dawn for all of us with a bank account. That it will probably do little to curb the banks’ bad behaviour will be yet another black mark on the stained copybook of the Financial Services Authority (FSA).
The first of the month is when the chief City watchdog will take over the policing of retail banking. The Banking Code, the cosy system of self-regulation that has allowed poor service and bad practice to flourish, will be consigned to the dustbin.
Few will mourn its passing, as tighter regulation is long overdue. But what is the point of replacing a broken system with a replacement that looks fundamentally flawed?
When the FSA announced that it was taking over banking regulation, it promised greater transparency for consumers. A noble goal, but one that, on November 1, it will singularly fail to achieve. There are few things to commend the Banking Code but, in its favour, it is clear and easy to understand. At 37 pages of large print, you can just about absorb it in a single sitting.

Under the new regime, the code will be replaced with three separate directives. I can’t be the only one to think that one into three sounds like a recipe for befuddlement. The FSA will oversee two of the strands — the Banking: Conduct of Business Sourcebook and the Payment Services Directive. These broadly cover how banks deal with customers with cash deposits. Overdrafts, loans and credit cards will continue to be policed by the Banking Code Standards Board in its new guise of the Lending Standards Board.
If you are keen to acquaint yourself with the rules, prepare for more than 100 pages of the finest legalese. The FSA has promised to publish reader-friendly guides before the November deadline, but this week was unable to confirm when.
Why do we need three sets of rules in any case? This cobbled-together compromise results from a decades-old division between the regulation of banking and credit that should have been binned long ago.
It is a shame, because the new rules contain some good ideas. In fraud cases banks will have to prove that the customer was at fault. Currently the onus is on customers to prove that they did nothing wrong. Another positive move will require banks to give most customers two months’ notice of any interest rate changes.
The FSA will also be able to fine banks and building societies that fail to treat customers fairly — although that has not proved a deterrent to bad behaviour in the past. It may stop the big institutional abuses, but many more cases will continue to slip through the net.
All in all, this looks like a missed opportunity to swing regulation decisively in the customer’s favour.
Aviva’s radical pensions proposal may be a winner
Radical thinking on pensions is the order of the day. But amid all this week’s hoo-ha about Tory plans to increase the retirement age, you might have missed a call by Aviva to abolish higher-rate tax relief on pension contributions.
Britain’s biggest insurer reasons that a single rate of 30 per cent for all taxpayers would simplify pensions and encourage people to save for retirement.
It provoked a predictable response: such a move would be “disastrous” and discourage higher-rate taxpayers from saving in pensions. But would it? And — here’s a more radical notion — should we care?
For the 25 million basic-rate taxpayers, millions of whom do not save at all, the measure looks like a winner. The rate would be a halfway house between the 20 per cent relief paid to basic-rate taxpayers and the 40 per cent available to those paying tax at the higher rate.
Aviva reckons that it could add up to £50,000 to the pension pot of a basic-rate taxpayer. At a stroke, it would redress the imbalance by which 55 per cent of tax relief goes to the 2.5 million higher-rate taxpayers, most of them men. Everyone would receive the same incentive for the same level of saving — a fairer system. Higher-rate taxpayers would certainly lose out, but wouldn’t a government contribution of 30p in every £1 still be enough incentive? If not, the chances are that most will save in a different form, such as Isas or other tax-favoured products.
A harmonised rate would make things simpler all round. There are bound to be problems when it is introduced, but the pain would not last long. And according to the Pensions Policy Institute it would cost about the same as the existing system — passing the austerity test.
It may not be the answer, but Aviva deserves to be listened to.
Bingo … take a punt on your pensions pot
Mixing gambling and pensions usually ends in disaster. But there are exceptions to every rule. To encourage greater take-up of the pension credit, the Department for Work and Pensions (DWP) is touring Mecca bingo halls across the land. A shocking £5 billion of pension credit goes unclaimed every year.
Since the people won’t come to the pension credit, the DWP has decided to take the pension credit to the people. The credit clearly isn’t working and should be abolished, but there is no point missing out on the top-up in the meantime. Check if you qualify at direct.gov.uk.

Chancellor beats off German move to cap bankers’ bonuses

By
Mail On Sunday Reporter
Last updated at 10:21 PM on 05th September 2009

Capped: Alistair Darling says he has been victorious over bankers’ pay self-regulation
Alistair Darling last night claimed victory over French and German
efforts to cap bankers’ bonuses - but was accused of shelving the
controversial issue
of City pay. Speaking after a meeting of finance ministers from the group of 20 leading economies, the Chancellor said the regulation of bankers’ pay would be farmed out to an international body for ‘examination’. The Financial Stability Board, made up of representatives of central
banks and regulators from around the world, will look at ways of
monitoring the size of bonus pools in major financial centres. The decision came as Downing Street sources indicated that Gordon Brown
would go ‘on the offensive’ next week to claim Tory spending cuts would
lead to a ‘double-dip recession’ - a second slowdown following the
UK’s recovery from its current malaise.Mr Darling fended off attempts by France and Germany for a cap on the
bonuses of individual financial market players - which would have been
the first period of pay controls for private employees in the UK since
1979. He said: ‘Under what we have agreed today we will be able to see in
each firm who is getting these bonuses, whether they are at the top or
the bottom of the organisation.’ Mr Darling called for bonuses to be spread over a number of years and
to be subject to ‘claw back’ should an individual be found to have
taken unnecessary risks.
The decision meant the issue has been deferred until a meeting of G20
leaders at the end of this month in Pittsburgh, United States.Dr Gerard Lyons, chief economist with Standard Chartered, said the
Government had successfully kicked the bonus issue into the long grass.He said: ‘Two wrongs do not make a right. People may, in the past, have
been irresponsible in business but caps on bonuses are not the answer.’

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Davos finds no answers to crisis

By Tim Weber
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The World Economic Forum has ended with a call to rebuild the global economic system.

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Present worries

By Kevin Peachey
Consumer affairs reporter, BBC News

The shining Gibson guitar was going for a song on the internet, but any expert could hear it did not play like the real thing.

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