The limits of financial regulation

In November last year, the Chancellor wrote to the Governor of the Bank of England asking him to look into the possibility of introducing a leverage ratio for banks. In the exchange of letters the Chancellor made clear his feelings that a ratio of this sort, which would limit bank borrowing levels, would make Britain’s financial system more stable.

But does there come a point at which financial regulation begins to have the opposite effect to the one intended? Is it the case that regulation provides an illusion of safety thereby encouraging complacency?

The consequences of this are not confined to the Square Mile. High street financial products also come slathered in regulatory small print, much of which serves only to give the impression that the regulators have done their work and that the thing is essentially safe. But high street scandals, not least that over interest rate swaps, show clearly that consumers should not presume to rely on regulators, a point taken up by Anthony Browne, chief executive of the British Bankers’ Association, who stresses the importance of “caveat emptor”—the notion that ultimately, consumers should rely not on regulators, but on themselves.

As the Governor of the Bank’s letter to the Chancellor made clear the Basel Committee on Bank Supervision will be reporting shortly with a technical definition of a leverage ratio and if the Chancellor manages to set a ratio in place, then he will use it as an opportunity to present the government as being tough on the banks. Even so, it will be worth remembering that as history has repeatedly shown, regulation alone cannot save people from themselves.