Finance and Economy

The Wrong Pheonix Rising

It is no secret that the lobbying might of financial institutions has shaped regulatory rules at national, European and global level. But did the disaster of the 2007 financial crisis change this? The honest answer is that the old institutions are still up to their old tricks, and a change in how we make policy is needed if we are to avoid a repeat of the crisis.

European companies rely heavily on bank financing, making the European banking market the world’s largest. The crisis in the banking sector and the resulting regulatory reforms therefore have direct implications for the prospects of European economies to implement a Green New Deal and recover from the crisis, even more so than in other advanced economies.  Elsewhere in this edition of the Green European Journal, Green MEP Philippe Lamberts points to the ‘blackmail’ by the largest financial players, holding society ransom to secure their profits. That begs the question whether the crisis has led to a change in the way European policymakers confront the banking lobby, and whether this results in strengthened regulation that ensures stability. This article will try to answer these questions by looking at one crucially important regulatory domain: bank capital adequacy standards. These standards aim to ensure banks hold a sufficient buffer to weather adverse conditions.

At the global level, the Basel capital accords of the Basel Committee on Banking Supervision (BCBS) set the standards for bank capital adequacy. Supervisors from the main European financial markets are members of the BCBS, and the European Central Bank (ECB) and Commission are observers. The Basel accords have been transposed into the EU context through several directives, most recently through the fourth Capital Requirements Directive (CRD IV). That’s the official side of the policymaking process. On the other side, the article will show the rampant and heavily biased lobbying taking place in the making of banking regulation, and how that is reflected in the final regulations. The article will conclude with some concrete suggestions on how to improve the democratic legitimacy of regulations through addressing the influence of lobbying. But let‘s start with the policymaking process.

Financial policymaking in the EU

A major problem with global financial policymaking is the exclusionary policy-making forums in which it takes place, leading to limited and skewed discussions (see Underhill, Blom and Mügge 2010; and particularly the chapter by Baker in that volume). As a result, public policy-makers have developed shared assumptions including the superiority of market mechanisms and the desirability of levelling the playing field (‘increased competition leads to more efficient financial services provision’). Bank capital adequacy was also addressed through this market-oriented lense, by allowing the major banks to use their own models to determine necessary capital under the Basel II capital accord.

It became clear for everyone to see that the global banks successfully privatised their gains and socialised their losses.

European policymakers encouraged this global goal of leveling the playing field with an eye to using the Basel capital accords to further European financial market integration (Bieling and Jäger 2009). This is reflected in the application of the Basel capital accords to all European banks, even though the accords were originally envisaged to apply only to large internationalised banks (and are implemented as such by, for example, the US). In addition, CRD IV has strengthened provisions on consolidated supervision for EU banks (Christopoulos and Quaglia 2009: 18). This makes cross-border operations in Europe easier for banks.

The market-oriented lenses of financial policymakers did not emerge out of thin air. Throughout the regulatory process, there was fierce lobbying by the banking industry. An industry representative confided to me that when the BCBS was working on particular issues in the Basel II accord, his association would be called on to organise a high-level meeting with BCBS officials. This lobbying is shown in the responses to the consultative papers which the BCBS issued (see Blom 2011: 133, table 4.5 for more details). The vast majority of comments came from private financial actors (about 70 per cent) and supervisors (another 15 per cent, these were regularly drafted in explicit consultation with the domestic financial sector). Only a handful of Civil Society Organisations provided input, out of a total of 443 comment letters in two rounds.

Brussels under the lobbyist’s influence

The European implementation of Basel II simply provided another chance for lobbying. The banking sector was closely involved in the negotiations at the European level, leading the European Banking Federation to commend the Commission for the unprecedented level of consultation (Financial Times, 15 July 2004). The EP proved a magnet for lobbying, with a package of almost 600 amendments tabled during discussions between the Commission, Council, and Parliament. Many amendments aimed to address national idiosyncrasies, while the internationally active private sector lobbied to reduce national discretions—and thus to defeat such amendments. Despite all the amendments tabled, the main philosophy and thrust of Basel II remained intact (Dierick et al. 2005).

The global financial storm gathering pace in 2007 revealed the inadequacy of extant bank capital adequacy levels. The internal models of banks as well as external rating agencies spectacularly failed to assess the risks associated with complex securitised products. Many banks experienced liquidity or even solvency problems and required state support. It became clear for everyone to see that the global banks successfully privatised their gains and socialised their losses. The collapse of Lehman Brothers and the narrowly avoided global financial meltdown in September 2008 was the final straw. As the newly appointed FSA chair Lord Turner put it: a clean slate for capital adequacy standards was needed (Financial Times, 17 October 2008). But did the intensifying political fights around financial regulation – now that taxpayer’s money was visibly involved – also weaken the banking lobby?

In the wake of the crisis: the private sector on the ropes?

The crisis seemed to offer a wake-up call to strengthen financial regulations. The BCBS duly proposed ‘enhancements’ to Basel II in January 2009. These included liquidity risk provisions, the better modelling of securitisations, a stricter definition of capital, cyclically adjusted capital buffers, higher capital requirements for systemically relevant banks, and a gearing ratio (see the overview in Goldbach and Kerwer 2012). This latter proposal (also called a leverage ratio) sets a capital requirement against the balance sheet total of a bank (without risk-weighting) and is a clear departure from Basel II practice. This measure, long in place in the USA, proved quite contentious in Europe, where banks are unfamiliar with the practice. BNP Paribas, for example, stated: ‘except for its extreme (excessive…) simplicity, this indicator has no clear objective and justification; furthermore, it has proven failures or flawed definitions wherever it has been applied, in particular in the USA’ (16 April 2010).

The central line of defence against strengthened regulation of the private sector lobby was the supposed negative economic impact of stringent capital requirements. This was repeated in almost all private sector responses to the various consultative papers on Basel III (these can be found on the BIS website). The banking lobby used the weak economic environment to plead for a delayed phase-in of stringent Basel III requirements. They pointed to politicians’ demands that banks contribute to funding the economic recovery, and claimed they would be unable to do so with the ‘excessive’ Basel III requirements (Financial Times, 12 April 2010). This argument resonated with Eurozone supervisors, where the financial crisis had transformed into a sovereign debt crisis hampering economic recovery.

Another lobbying success

The banking lobby was successful in paring down the most controversial aspects of Basel III. Given the uncertain economic conditions, supervisors were hesitant to push stringent regulations (even some who traditionally favoured stringent standards – notably Germany). Although the new accord includes a more stringent definition of capital and an increase in the buffer, its phase-in is planned to last until 2018. In response to the criticisms from especially the European financial sector, the leverage ratio will only be ‘tested’ until 2017. In other words, the precarious economic situation in Europe led public supervisors to give in to the demands of their private sector. This was certainly also related to the weak balance sheet of German and French banks, which would simply not be able to meet stringent capital requirements (Howarth and Quaglia 2013).

Balanced decision-making requires that not only banks are heard in the discussion, but also the users of financial services, from innovative green SMEs, to pension funds, to ordinary citizens.

But even in the face of financial crisis, European public policymakers did not forget the goal of market integration. An important part of Basel III will be transposed through a ‘regulation’—meaning it will apply directly in Member States. This will limit the scope for the national idiosyncrasies that emerged under CRD III. Another Commission proposal hinted at setting Basel III norms as an absolute rather than a minimum standard (as the BCBS sees it). Such ‘maximum harmonisation’ would mean that countries with large banking sectors can no longer set additional capital requirements (e.g. the traditional ‘gold plating’ of the UK). It would also make it impossible for frontrunners – which will hopefully soon emerge – to include additional capital requirements for environmentally risky investments. Thankfully, maximum harmonisation was defeated in the European Parliament.

Conclusion

The discussion above demonstrated the significant impact of the financial sector lobby on financial regulation. This has led to a bias in the rules favouring market practices of large internationally active banks. Moreover, as the discussion of Basel III showed, the private sector lobby quickly re-asserted itself after the crisis and delayed more stringent regulations. This allows more time for the lobby to grind down the support for stringent regulation. The effects are already becoming visible: Financial Times, 13 January 2014 headline ‘Banks Win Basel Concession on Debt Rules’. Like a phoenix from the ashes, the lobby of bailed-out banks has risen to beat down stringent implementation of regulation.

So what is to be done? First, the range of stakeholders involved in the financial policymaking process should be increased. Balanced decision-making requires that not only banks are heard in the discussion, but also the users of financial services, from innovative green SMEs, to pension funds, to ordinary citizens (e.g. represented through Finance Watch). Elsewhere, I have proposed an institutionalised system of ‘corporatist’ representation of stakeholders to achieve this (Underhill and Blom 2013). More importantly, the democratic accountability of the policymaking process should be enhanced. It is the phoenix of democratic citizenship which I hope to see rise out of the ashes, holding those who contributed to the crisis (e.g. by advocating financial liberalisation) to account. This requires transparency on what is going on in the regulatory process from both the official and the other side.  A strong and clear ‘legislative footprint’ should be included when financial regulations are put forward to the European Parliament: a discussion on the on the inputs received from lobbyists and stakeholders and how these have been included in the final outcomes. This allows parliamentarians to judge whether an adequate balancing of stakeholder interests has taken place, and determine whether they should actively seek additional views from neglected parties. Secondly, there should be more transparency from those doing the lobbying. Not only a beefed-up lobbyist register, but also transparency on the side of banks and other stakeholders on lobby activities such as discussions with policymakers and the funding of studies (See Van Tilburg and Römgens 2013 for more detailed recommendations).

Notwithstanding the aforementioned proposals, it should also not be underestimated to what extent this bias in favour of large, internationally active banks operating on the basis of the old model of expansion and growth is supported by politicians currently in office. The discussion showed how European policymakers use global regulations to promote the growth and integration of European financial markets. Although bank capital adequacy standards at the global and European levels are not a one-on-one reflection of ‘capture’ of regulators, it is a matter of serious doubt whether public interests have received sufficient consideration. As the world has once again experienced the devastating effects financial instability can bring, this is a worrying conclusion. Fortunately, the elections for European Parliament of May 2014 offer one of those opportunities to hold the official side to account.

 

This article is a shortened adaptation of the author’s forthcoming chapter in Mügge, D.K. (ed.) (2014) Europe and the Governance of Global Finance, Oxford University Press.

References

Blom, J.G.W. (2011) Banking on the Public: market competition and shifting patterns of governance, PhD thesis University of Amsterdam
BNP Paribas, [no title, response to BCBS December 2009 consultative documents], 16 April 2010
FT, ‘Financials seek to soften Basel stance’ 12 April 2010.
FT, ‘Banks Win Basel Concession on Debt Rules’ 13 January 2014.
Goldbach, R. and D. Kerwer (2012) ‘New capital rules? Reforming Basel banking standards after the financial crisis’ in: Maintz, R. (ed.), Crisis and control: institutional change in financial market regulation, Campus Verlag, p. 247-262
Howarth, D. and L. Quaglia (2013) ‘Banking on stability: the political economy of new capital requirements in the European Union’ Journal of European Integration, vol 35:3, p. 333-346
Underhill, G.R.D. & J. Blom, Global financial integration, twin crises, and the enduring search for financial stability, CEPR policy report, 2013
Underhill, G.R.D., Blom, J. and D. Mügge (2010) Global financial integration thirty years on, from reform to crisis, Cambridge University Press
Van Tilburg, R. & I. D.J. Römgens (2013) Taking Lobbying Public: The Transparency of Dutch Banks’ Lobbying Activities, SOMO

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The Wrong Pheonix Rising

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