When regulators become nationalists

Regulators like to present themselves as the dull but dutiful guardians of financial stability –apolitical technocrats reading out the safety instructions on what to do if the plane you’re on makes an emergency landing. But bankers increasingly feel their regulators are in the cockpit, telling the pilots how to fly.

Policy-makers seem to have ambitions to join them.

In the early days after 2008, having regulators who just got on with the job of avoiding another financial crisis was understandably appealing. But the crisis is retreating into the rearview mirror, and the politics of international co-operation that gave birth to the 2009 G20 Pittsburgh declaration and the creation of the Financial Stability Board are giving way to something else – the re-emergence of economic nationalism.

US president Donald Trump’s America First trade policies and the then UK finance minister Philip Hammond’s suggestion of cutting corporate tax rates after Brexit to lure business out of the European Union are held up as the two most obvious examples of this trend.

In the realms of financial regulation, the US prudential agencies have also been toughening their stance towards foreign banking organisations. But EU member states other than the UK – the EU27 – are not immune either.

Some of the moves from Brussels have been a defensive reaction to Brexit, as the EU’s largest financial centre prepares to leave its jurisdiction. The departure raises the question of what regulators can do to prevent financial problems in the UK blowing back into the EU27. The legislative response includes the new, more restrictive equivalence regime for foreign clearing houses.

Some measures are clearly designed with one eye on the global competitive landscape. Changing the capital treatment of banks’ software assets falls squarely into that category

Some measures are clearly designed with one eye on the global competitive landscape. Changing the capital treatment of banks’ software assets falls squarely into that category. European lawmakers drafting the second Capital Requirements Regulation (CRR II) last year wanted to end the practice of forcing banks to deduct the entire value of their software assets from capital.

US banks are already allowed to simply risk-weight their software assets (at 100%), meaning they need to hold 12 times less capital against their IT than their European counterparts. This clearly provides US firms with a better incentive to invest in the technology, which could make all the difference between winners and losers in the banking sector.

Initially, the European Banking Authority stuck to its technocratic image and read out the safety instructions. In a letter to lawmakers in October 2018, the then chairman Andrea Enria warned: “Software treatment should not be hastily changed, given that deduction as presently applied still reflects the likely absence of value of software in resolution and even more in liquidation.”

But the tone seems to be changing.

“One aspect”

The EBA’s head of capital, Delphine Reymondon, tells Risk.net that the question of an international level playing field is “one aspect among others” in considering how to implement the new rules. Only one aspect, but that still means it’s at least on the agency’s agenda.

So, is the apolitical regulator succumbing to a desire to make European banks great again? Maybe not.

Unless a bank’s business model is manifestly unsustainable – for instance, terrible loan-underwriting practices – regulators generally feel a little uncomfortable with the idea of their rules altering day-to-day commercial decisions.

At a time when analysts believe digital transformation could be soaking up as much as 80% of banks’ total investment budgets, full capital deduction for those investments can (with some justification) be painted as a restriction on bankers’ ability to do their job properly.

Changing this treatment is therefore a welcome step that could help put bankers back in control of their own – hopefully high-tech – cockpit.