The agencies that regulate financial markets are master craftsmen of detailed rule books. For decades, they have seen this as their main job, and for good reason. Companies prefer clear rules. Legislators want to avoid handing discretionary powers to unelected regulatory agencies. And the public rightly wants to know the standards to which companies are being held.
But there is an unfortunate flipside. Detailed rule books are the meat and drink of regulatory arbitrage. Finance is a shape-shifting industry. Complex regulations can seem to legitimise the practice of burrowing through the holes they inevitably contain. And rigid rules are of little use when activity moves outside the regulated sector.
This matters. As banking regulation becomes more stringent once again – with greater constraints on the structure of banks’ balance sheets and on the types of asset they hold – some of the substance of banking will inevitably re-emerge elsewhere. This means that tightening banking regulation is not sufficient to prevent excessive liquidity risk and leverage among