On Wednesday, the NY Attorney General subpoenaed internal documents and communications among executives of several major foreign and US banks that were participants in submitting daily input to the British Bankers’ Association LIBOR fixing. This move comes on the heels of the New York State Department of Financial Services having achieved a $340 million dollar settlement with the UK’s Standard Chartered PLC over alleged money laundering activities in violation of US law. UK and US regulators were taken by surprise by the allegations against Standard Chartered, the lack of coordination and advance notice about the charges, and the swiftness of the settlement. The Bank of England’s Mervyn King complained about that lack of coordination and what he viewed as unfair targeting of UK banks.
The NY AG’s actions are most important in terms of their implications for the politics of the regulation of international banks, and are a testament to the benefits of regulatory competition. The LIBOR issue has been festering since 2008, when the Fed brought concerns about the index to UK authorities. Nothing of significance was done until recently, when the issue was exposed to the light of day. It has subsequently become apparent that the LIBOR fixing process was corrupted long before 2008, and more information on just how deep the problems ran will become public knowledge as civil suits proceed. Meanwhile, the regulators’ reviews and investigations continue to move at glacial speed. What the Department of Financial Services’ Standard Chartered settlement shows is that it doesn’t take years to investigate and settle financial institution wrongdoing. What exactly is the problem here?
When Hank Paulson took over as Secretary of the Treasury, he decried regulatory complexity and overlap and argued for consolidation of responsibility. Similarly, in the mid-nineties the UK took the extraordinary step of removing the Bank of England from banking supervision and vesting that responsibility with the Financial Services Authority (FSA), which had a broad mandate to regulate financial institutions and markets. However, that structure resulted in many examples of failed regulatory oversight, including the failure and run on Northern Rock, the LIBOR scandal, loose enforcement of capital standards in UK banks, and now Standard Chartered. It is clear that regulatory consolidation is not the answer, and the UK is in the process of eliminating the FSA and folding many of its functions back into the Bank of England.
One of the reasons many academics support competition among regulators is what is known as “regulatory capture.” This is a variant of the Stockholm syndrome in reverse, where the regulator becomes so close to and sympathetic with the institutions it regulates that it can’t pursue arms-length regulatory actions on behalf of the public and taxpayers it is charged to protect. There are many examples in the US where, despite obvious inefficiencies and jurisdictional overlaps, regulatory competition has led to better outcomes. One of the most important examples lies in the area of financial disclosures by banking institutions. Prior to 1971, when the banking regulators had sole responsibility for enforcing the securities laws as they applied to banks, data on bank income and expenses was not publicly available, and disclosing such information was illegal. The disclosure policies changed significantly when the bank holding company movement grew to significance during the 1970s. The SEC gained disclosure authority over bank holding companies, because they weren’t banks, and therefore, was able to force more disclosures by banking organizations. The reason the banking regulators didn’t want bank income information to be available was the fear that it would cause a run on banks, which has proved to be unfounded. Regulatory competition resulted in a better tradeoff, especially when it came to the interests of investors.
The regulatory capture problem is even worse in Europe because governments have major financial stakes in the institutions they regulate. Conflicts of interest abound in such circumstances and are usually resolved by governments protecting and/or bailing out the institutions they own to save face, usually in the name of avoiding a financial crisis. The protection instinct is extremely strong, witness Mervyn King’s aforementioned claim that UK institutions are being singled out unfairly by US regulators. The end result leads to moral hazard behavior on the part of protected institutions.
What the NY authorities have done is poke a stick at both US and UK regulatory bodies. This is not the first time that a NY has authorities have interjected themselves into financial regulatory issues that have been languishing. Hopefully, the result will be to speed up the ongoing LIBOR investigations. Clearly, the NY AG will seek a quick settlement which, if successful, threatens to embarrass banking supervisors both in the US and UK. The NY authorities interventions may be one of those clear examples where agents outside the “club” force actions that would not otherwise occur, but for regulatory competition.
