Congress, lobbyists and editorial writers have been engaged in an intense debate over how to provide effective governance for the US banking system in the wake of the 2008 financial crisis and, more recently, JPMorgan Chase’s billion-dollar derivatives losses. It is a complex subject and, not surprisingly, the language has been at times as opaque as the derivatives themselves – and the inability of the public to understand the system is contributing to a decline in trust and confidence. I believe the real solution lies in formulating a simpler, not a more complex, set of regulations.
Begin with the reality that banks’ operations are vastly different now than they were even 10 years ago. The days when a large multinational bank could borrow money from depositors – backed by a government insurance guarantee – and then lend it out to customers at a reasonable spread are gone, at least as their main source of revenues. With net margins squeezed, banks have had to reach for profits in increasingly esoteric areas, such as derivatives trading, which rely on complicated computer models and mathematical algorithms few people understand.
Most of these activities boost profits by cranking up leverage, which the banks feel comfortable using because of confidence in their computer models. As this is a highly complex process, in turn, the regulatory oversight must grow in complexity simultaneously. Consider that despite more than a year of effort the standards for implementing the so-called Volcker rule, intended simply to prevent banks from engaging in proprietary trading, have become exceedingly complex and have yet to be finalised. (Paul Volcker’s original idea is a prudent step that I support.)