Increase Transparency of Banks – Best Regulation

One can question if the root causes of the crisis were lack of regulation and that the OTC derivatives markets were not properly monitored. Surely the explosion of OTC derivative contracts was an effect of the credit expansion started in the early 80-ties rather than the other way round. The main cause behind the large swings is too much debt. We need to keep that in the back of our mind.

I have studied the work by the EU commission on regulation of OTC derivatives. What strikes me is that regulating separate areas independently seems to be easier than putting the new regulatory framework into context. I am particularly struck by the limited perspective of the discussion. It mainly revolves around banks and other financial institutions when it actually affects the whole society. The corporates are only involved in the periphery of the regulatory discussions.

The key, I believe, for sound financial regulation is to increase the transparency of the banks’ financial accounts. For many years the accounts have been impossible to decipher because the regulators have been keen on not forcing banks to disclose information to the market with regards to competition. But the fact is that banks do not compete in the general sense of the word.

Competition means having the risk of going bankrupt because your competitors take your market. No bank risks that. The banks go bankrupt when they take too much risk, have insufficient controls and bad management. I feel compelled to question if the regulators and bank supervisors know what competition really is.

Compare the transparency of corporate accounts with that of financial institutions. Why can corporates have transparent accounts when the banks can’t? Because the banks are more exposed to competition than corporates?

A more holistic perspective on regulation would be to force the banks to become transparent and enable us to understand what risk their business model and balance sheet entails. Force the banks to become as transparent as the corporates so we all can make our analysis. Now the only parties having sufficient information to evaluate a bank’s risk position are the supervisors. And what can they do about a bank taking too much risk? What can they do about systemic risk? Basically nothing.

However if everyone would have sufficient information of each bank’s positions everyone would price the bank’s shares and choose to transact with the bank based on their own judgment. This is how we usually organize society and free markets. Why shall we not do the same in the financial markets?