Banking regulation: a quick look

What controls do governments across the world place on investment banks? Will Hodges gives you the details

The UK

What's happening?

The UK has arguably led the way globally in the reform of financial regulation. The coalition government has undertaken a gradual but significant overhaul of the UK's financial regulatory system.

Reform of the FSA

The UK finance industry's main regulatory body is the Financial Services Authority (FSA). It's currently being restructured into two separate entities - the Prudential Regulatory Authority (PRA) and the Financial Conduct Authority (FCA).

The PRA will focus on whether banks, insurers and investment firms are financially sound, while the FCA will monitor how they go about their business. The ultimate monitor of the UK financial sector will be the Financial Policy Committee (FPC), an umbrella organisation within the Bank of England that will look at systemic risks across the UK's financial services industry as a whole.

These changes to the structure of the UK's main regulator have been accompanied by a significantly more aggressive attitude towards breaches of the rules.

The Vickers report

The other key regulatory step taken by the coalition government has been the establishment of the Independent Commission on Banking, set up to consider why the financial crisis happened and what reforms should be made to the UK's banking system as a result.

The ICB's report, known as the "Vickers report" after the commission's chair, economist Sir John Vickers, was published in early autumn 2011. Summer 2012 saw the publication of the coalition government's response. It also agreed that the operations of major high street banks involving the money of ordinary individuals should, with some exceptions, be ring-fenced from their investment banking activities. The government also agreed with the ICB that the amount of capital banks are required to hold in reserve against financial shocks should rise. The third key Vickers proposal that the government accepted was the introduction of measures to strengthen the UK's banking sector through increased competition.

Bonuses

In September 2012, Labour Party leader Ed Miliband called for a tax on bankers' bonuses to be introduced in order to pay for the construction new homes. The UK has experimented with taxing bonuses in the past, having implemented a one-off 50 per cent levy on bonuses in 2009.

The US

What's happening?

The approach taken in the US is similar in many ways to that of the UK. Over the past few years, significant new regulation of the banking sector has been introduced.

The Dodd-Frank Act

After taking office in January 2009, President Obama wasted little time in proposing a series of radical alterations to the US financial regulatory system. 18 months later, after persistent lobbying by Obama's Democratic Party, the Dodd-Frank Act was passed by Congress. It's been described as the most significant reform of the US financial sector since President Roosevelt's New Deal provisions, some 75 years previously. The act is named after Chris Dodd and Barney Frank, the two members of Congress responsible for proposing the bill.

One of the main aspects of the Dodd-Frank Act was the creation of the Financial Stability Oversight Council (FSOC), a government body comprising federal and state regulators that meets regularly to monitor systemic risk to the country's financial system. The act also included more regulation of the financial markets and increased consumer protection.

The Volcker rule

This rule, part of the Dodd-Frank Act, was named after American economist and former Federal Reserve Chairman Paul Volcker who proposed it. It states that banks taking deposits from ordinary individuals will not be allowed to engage in trading on their own behalf. In addition, banks will not be allowed in the future to operate their own trading vehicles such as hedge funds or private equity funds.

Bonuses

The US government has yet to implement any rules regarding bonuses, though new measures are thought to be in the pipeline. However, many financial institutions are adapting their own new bonus structures, in response to the ongoing changes to the country's financial regulatory structure. Many companies, for example, have undertaken a policy of deferring bonuses, meaning that while previously the lion's share of bonuses would be paid up-front to employees in cash, many will now receive longer-term rewards in the forms of share options or deferred cash payments.

The EU

What's happening?

Recent changes to financial regulation in Europe have focused on preventing future banking collapses as the failure of some smaller banks has been identified as a major contributor to the EU's current economic problems.

Stress tests

These involve putting EU banks through a series of simulated financial catastrophes with the aim of identifying those banks which are unlikely to be able to withstand shocks to the financial sector. The most recent test, conducted in July 2011, saw eight out of 90 European banks fail to pass.

Consolidation

The EU has been pushing for the consolidation of the banking sector in an effort to tidy up the industry. To aid consolidation, EU laws have been passed requiring firms to spend a greater proportion of their revenues on financial compliance, meaning smaller firms which are unable to afford these outlays have had little choice but to merge with market leaders.

Cameron's EU treaty veto

In December 2011, the UK's prime minister, David Cameron, was the only EU leader to reject the terms of a new treaty implementing a common EU financial regulatory model, claiming that many of its policies, including plans for a EU financial transactions tax, would be detrimental to the UK's financial services industry. The UK is now likely to be excluded from involvement in the creation of a single EU financial regulatory body over the next few years.

Bonuses

Because of a widely-held belief that "bonus culture" had led to excessive and damaging risk-taking, new EU bonus guidelines were introduced by the Committee of European Banking Supervisors (CEBS) in December 2012. They recommended that financial institutions should only pay a maximum of 20-30 per cent of bonuses up front and 40-60 per cent of the overall bonus should be deferred for three to five years. They stated in addition that at least 50 per cent of any bonus should be paid in the form of shares. The CEBS is also aiming to set a maximum bonus level relative to an employee's basic salary.

Is there any global regulation?

There is currently no global banking regulatory body. However, several times over the past few decades a committee made up of representatives from central banks and regulatory authorities in the world's key economies has met in Basel, Switzerland to discuss banking supervision and to attempt to establish a universal framework for banking regulation.

The result of these meetings has been the Basel Accords - Basel I of 1988, Basel II of 2004 and Basel III of 2010-11. Their main impact has been to propose an increase to banks' reserve requirements - that is, the amount of money they're required to hold in reserve to ensure they have enough to cover their liabilities if any of the entities they lend to are unable to repay them. Basel III, devised after the financial crisis, is the most stringent and its requirements are aimed at preventing the "domino effect" which led to instability across the banking sector following the collapse of Lehman Brothers in 2008.

It's important to remember, though, that the Basel rules are guidelines only and require implementation by national governments in order to have any effect.

Regulate that: 5 recent banking scandals

LIBOR

In what was arguably the biggest financial scandal of 2012, Barclays employees at Barclays and some other banks were revealed to have been artificially manipulating the London Interbank Lending Rate (LIBOR) in order to benefit the company's trading activities. The revelations led to the resignation of chief executive Bob Diamond and to Barclays receiving a record £290 million fine from the FSA.

Insider trading

In July 2012, Nomura chief executive Kenichi Watanabe was forced to resign after an insider trading scandal came to light. Traders at the bank were reported to have leaked information to customers about deals in which the bank was involved before it was made public.

Risky business

US investment bank J.P. Morgan suffered heavy losses earlier this year when trader Bruno Iksi traded away a reported £3.8 million through a series of risky transactions. An internal investigation revealed that the company's investment team had been miscalculating financial risk. The affair led to the resignation of Ina Drew, J.P. Morgan's chief investment officer.

Misselling PPI

2011 witnessed the unravelling of a scandal involving several leading UK high street banks accused of misselling payment protection insurance (PPI), which was intended to cover the loan repayments of individuals who find themselves unable to work or suffer a significant reduction in income. The FSA has forced banks to make £9 billion available to compensate affected customers.

Iran

In August 2012, US bank Standard Chartered was accused of contravening US sanctions on trading with Iranian companies after having apparently laundered around £165 million of Iranian money through the firm's New York office. Standard Chartered has denied the allegations, claiming that the transactions were not in violation of the sanctions. However, the bank was nearly banned from operating in the New York financial sector.

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