Institute for Financial Transparency

Shining a light on the opaque corners of finance


Gaming the Rules

Danièle Nouy, Chair of the Supervisory Board of the ECB, gave a speech in which she laid out why bank regulators and bank regulations won’t stop the next financial crisis.  As she observed:

In 1986, Nobel laureate Merton Miller noted: “The major impulses to successful innovations over the past 20 years have come, I am saddened to have to say, from regulation and taxes.”

It is true that banks can be highly innovative when it comes to reducing the regulatory burden. They are always tempted to game the rules. They are tempted to exploit loopholes and seize on the fact that rules differ across countries and sectors.

Such regulatory arbitrage is, of course, a problem. Rules are put in place for a reason, and working around them defeats that purpose. As you all know, we have just emerged from the worst financial crisis since the Great Depression. That’s why we have made these rules stronger: to make such crises less likely. Whenever a bank tries to get around the rules, it increases the risk of another crisis.

Of course banks will get around the rules.  The banks have an economic incentive to get around the rules and there is nothing bank regulators can do about it.

The banks are helped in getting around the rules by the fact they had a significant impact on how the post-crisis rules were written.  So they know exactly how to minimize the impact of these rules on their operations and profitability.

Ms. Nouy would like to sell the myth bank regulators close loopholes in their rules as soon as they discover banks are exploiting these loopholes.  Nothing could be further from the truth.

Writing and getting approval for new bank regulations is a time intensive exercise with an uncertain outcome.  It literally takes a financial crisis to get significant changes to the rules.  And these changes are so riddled with bank inserted loopholes that they are worthless.