Friday, March 28, 2008

Time for a hard look at banking oversight

(Gillian Tett at the FT) This spring, a bout of witch-hunting has broken out on Wall Street. After the implosion of Bear Stearns, politicians, investors, regulators and lawyers having been eagerly casting around for someone to blame (if not send to jail).

In London a similar game has started, albeit more subtly. This week, the Financial Services Authority issued a report on its treatment of Northern Rock, prior to its collapse. This casts the British regulators in a deeply unflattering light. Indeed, the sense of recrimination is now so intense that it has prompted reshuffles and departures at the FSA.

Perhaps such finger pointing is justified; I am not privy to the inner details of the FSA. However, I rather suspect that some of this misses the point. Irrespective of what individual supervisors did – or did not – do in relation to Northern Rock, the real issue that needs to be discussed is the wider system of banking oversight.

The big issue at stake, in other words, is not the finer details of regulatory rules, or the behaviour of a few individuals; instead it lies in the culture of regulation – or the sociology of supervisors, if you like.

There are at least two areas of concern. One revolves around the issue of status. As this week’s report points out, in recent years the FSA has been plagued by a high turnover of staff.

There is no particular mystery about why that should be. Jobs at the FSA tend to be lowly paid, compared with the City. Equally important, they also carry limited glamour within the civil service as a whole. If you are working as a supervisor, you tend to face a negative recognition problem – namely you usually only attract attention if you screw up. No wonder the FSA admits it sometimes faces recruiting challenges, both in the City and civil service

That, in turn, exacerbates a second problem: the difficulty that FSA staff face in terms of challenging the dominant financial creed.

During most of this decade, the financial industry has placed a near-religious faith in the idea that distributing credit risk (via securitisation, for instance) made banking safer. Moreover, bankers and policymakers have also taken it as gospel that innovation was an inherently good thing – implying, in turn, that the best regulatory regime has a light touch.

In retrospect, it is clear that this philosophy has been dangerously self-serving for the banks, prompting them into a perilous orgy of greed. However, in practice, it has been extremely hard for anyone to challenge the dominant gospel in recent years – be they a journalist, a politician or supervisor.

FSA supervisors tend to be former bankers, or drawn from the same intellectual and academic background. Moreover, they have increasingly succumbed to a “silo” mentality.

In particular (and as this week’s report notes) supervisors have been trained to spend their time ticking boxes, within their allotted silos, rather than take a holistic view of risk. FSA supervisors, in other words, were neither equipped nor authorised to challenge the gospel of securitisation, in respect of Northern Rock or anything else.

Is there any solution to all this? On the macro level, these events certainly undermine the case for separating supervision from central banking. However, on the micro level, there are two actions that can be taken in relation to supervisors – almost irrrespective of wherever they sit.

First, there is a strong case to raise the salaries of supervisors dramatically. London cannot hope to remain a world-class financial centre unless it seriously invests in infrastructure – be that the rail network, or regulatory skills.

But, second, there is a need to rethink the recruitment process. Yes, the FSA certainly needs to have ex-bankers in its ranks; but it also needs non-bankers or, at least, maverick voices who can throw hard questions at 30-something bankers – and the supervisors themselves. If there is one key moral from this decade, it is the danger of letting group-think spin out of control. And that point applies as much to the sorry sagas of Northern Rock and Bear Stearns – as the FSA and other western regulators too.

No comments: