When Thomas Hobbes exclaimed in the 17th century that ‘knowledge is power’ (or more accurately, ‘scientia potentia est’), it is pretty certain he wasn’t wrestling with the problem of how best to regulate the excessive behaviour of banking and financial services.
Yet there is a gaping hole in the government’s current plans to reform the Financial Services Authority – a vacuum of information which can only be filled if we learn the lesson that we need to know the detailed facts about the real time nature of global financial data.
Over the past three weeks I have been spending all day on Tuesdays and Thursdays with a dozen MPs trying to scrutinise the 313 pages of the Financial Services Bill in committee room 12. As Labour’s spokesperson on the Bill I have several criticisms of George Osborne’s plans to split the FSA into a new Prudential Regulation Authority and Financial Conduct Authority who will take close direction from the Governor of the Bank of England. There are deficiencies in accountability of the new regulators and a mismatch with the European supervisory authorities who can overrule them. But perhaps one of the greatest shortcomings is the regulators’ continued inadequacies in gathering data, improving transparency and ensuring timely disclosure within our financial system.
While the need to improve the systemic oversight and sustainability of financial services is clear, the success of a new ‘prudential regulation’ process will rest on the information and analytical capabilities available to those charged with forecasting potential crises before they hit – which is why I am proposing amendments to radically enhance the data collection system. In my view, the new PRA regulator must at the very least have the power to demand transaction-level transparency from the companies it regulates. America’s Dodd Frank Act already gives their regulators this power, through their Office of Financial Research.
Why is this level of rigour necessary? On 10th October 2007, the UK’s regulator did not stop a hostile takeover of ABN AMRO by the Royal Bank of Scotland, even though it noted the lack of information available. It felt the public nature of the ignorance was such that there could be no intervention. Only eleven months later, the same regulator stopped Barclays from buying a soon to be bankrupt Lehman Brothers, and it was only after this deal collapsed that Lehman filed for bankruptcy. Then the regulator felt that ignorance of what was going on was sufficient to stop the transaction.
Such a lack of information is now inexcusable. But improved data collection needn’t be a burden; investment banks are already reporting most of their financial transactions through centralised clearing operations. So if they’re doing this already, regulators should have access to that information. If our regulation following this Bill is going to be fit for the 21st century, we need to give our regulators a map of what the risks are in our financial system and where they’re concentrated. The Americans have already begun this by creating an Office of Financial Research, and we should make sure that the Bank of England has a data centre able to match these capabilities.
Doing this in the UK would require the creation of standardised databases of counterparties and financial instruments. Reporting could then be made to the Bank of England’s data centre in real time as and when each trade is transacted. The value to the City of these standardised databases should also not be underestimated. It would facilitate a much better consolidation of risk management within firms and allow further much-needed innovation in this area. Knowledge isn’t only essential for the regulator, it’s essential for banking executives too.
We all hope that there will never be another global crisis of the scale of 2008. But the post mortem of those events should be teaching us the right lessons. Not all banks lent recklessly, but the problem when the crisis came was that the regulator couldn’t discern the neglectful ones and guarantee the sensible ones. Instead, the Government had little choice but to protect the whole system. Next time, with regulators informed and armed with the measure of each player in the system, there should be no reward for failure. At times of collapse, the regulator could have clearer information on which investment banks were reckless – with no excuse to bailout losers.
There are many strands to renewing trust with the City, and fair remuneration is one of them. And many people want to let the City continue innovating and providing finance and supporting innovation. But until they believe that reckless behavior will be caught before we get to a system-wide collapse, they will withhold their support.
In February 2007 the then chief executive of RBS told shareholders that they had successfully avoided sub-prime lending. Unknown to shareholders, and only revealed in the FSA’s report on RBS’s demise, in fact, RBS had decided in June 2006, eight months prior to reassuring the market, that they would expand into the high risk structured credit business of US sub prime. They became so dominant that their “success” was recognised by the award of ‘North American Securitization Bank Of The Year’ for 2007. Though the erosion of RBS’s capital is often blamed on ABN’s toxic portfolio, of the £7.8bn lost in 2008, £5.5bn was lost in the old RBS, £2.3bn in ABN.
Whether RBS was too big, its business too complex, or it had people who just didn’t understand the products they were dealing with, we cannot continue with this private information remaining hidden within the banks. By creating a data centre within the Bank of England as envisaged by our amendment to the Bill, we can create a regulatory regime that is fit for purpose. Without it we leave our regulators blind; still regulating a 21st century system with 20th century tools. To regulate the banks without relevant information is to regulate in ignorance. I hope the Government sees the need for their Bill to contain the right tools to do the job properly.