x Abu Dhabi, UAEWednesday 24 January 2018

Forum divided on bank regulation

The agenda has been hijacked by controversy over the behaviour of the biggest Wall Street banks and the efforts to keep them from jeopardising the global economy again.

Khalid al Falih, the president and chief executive of Saudi Aramco, left, speaks with Thierry Desmarest, the chairman of Total.
Khalid al Falih, the president and chief executive of Saudi Aramco, left, speaks with Thierry Desmarest, the chairman of Total.

DAVOS // Everyone in Davos this year, it seems, is a regulator. Since the World Economic Forum's meeting began on Wednesday, its agenda has been hijacked by the controversy over the behaviour of the biggest Wall Street banks and the efforts to keep them from jeopardising the global economy again. There are sessions dedicated to redesigning capital markets and financial institutions, but even sessions unrelated to those topics often devolve into a discussion on what should, or what must, be done to the bankers. "I think the flavour of the week is banker-bashing, and I find it a bit boring," said Russell Loubser, the chief executive of the Johannesburg Stock Exchange in a session on African economies. "I wish the Davos community would just lift the debate and move on."

Everyone seems to agree that banks need to be better regulated. Even many bankers. "When banks need to be bailed out it demonstrates that the system failed," said Martin Blessing, the chairman of Germany's Commerzbank. "There needs to be a debate about regulatory change." But no one seems to agree on the best way to do that. Many fear that while popular opinion now demands some kind of punitive action, half-baked measures might prove a setback for economic recovery and even compound the problem. And efforts by one nation to bottle up its bankers, they say, could confound efforts to find an international solution.

"We are in danger of attacking the most visible problem without making sure what happened doesn't happen again," said Raghuram Rajan, a finance professor at the University of Chicago's Booth School of Business. The latest plan from Barack Obama, the US president, to charge a fee on banks that have received bailout funds and to ban them from running their own hedge-fund trading operations is finding mixed support.

George Soros, the chairman of Soros Fund Management, says he supports the plan, but that it is coming too soon. The US invested billions of taxpayer dollars in bailing out banks and then offered them cheap funding that they are using to earn profits that it is hoped they will use to rebuild their balance sheets. "To tax banks when you're trying to let them earn their way out of a hole goes against all your existing policies."

The problem is that banks are using the profits to reward employees instead of rebuilding their capital base, participants said. Many, therefore, support the Obama administration's plan to ban banks from proprietary trading. But bankers warn that doing so would interrupt the banks' normal function making markets for clients trading securities. Many use their proprietary trading desks to clear orders between their customers.

If the US forces out the so-called "prop desks", bankers warn, the global banks will merely relocate them in other countries, such as Switzerland or even the UAE. Some, therefore, say the Obama plan does not go far enough. Mr Soros is one of them. He and others think the biggest banks should be broken up the same way that trust-busters broke up America's big oil companies a century ago. "If financial institutions are too big to fail, they are too big and should be broken up," said Nouriel Roubini, the New York University Stern School of Business economist who is also chairman of Roubini Global Economics.

Others say breaking up big banks will not resolve anything. "Too big to fail is just one problem," said Mr Rajan. "You can also have too many to fail." Governments have had to bail out small banks as well. Ten smaller US banks failed this month, according to the Federal Deposit Insurance Corporation. Both of the banks Germany has bailed out so far are mid-sized. And if banks were trimmed back into financial bonsais, bankers say, big companies would suddenly be forced to split their business among several bankers. That would raise costs that companies would ultimately pass along to consumers. Thus, many participants support efforts by the Financial Stability Board to devise a new international agreement that would require banks to keep more capital on hand to offset the risks they take.

But many participants would like to see regulations become much more directly involved in how banks feed credit into the economy. While central banks in the West have largely tried to control banks' inclination to lend by raising or lowering interest rates, many here say they should return to the past practice of imposing direct controls on lending. One area where there is little disagreement is in the need to control trading in credit-default swaps, which provide insurance to investors against default. For those who buy a bond, such swaps help hedge their risk. But many investors trade credit-default swaps as a bet on a company's or country's financial health. If the issuer of the credit defaults, they cash in. "It's like being able to buy fire insurance on your neighbour's house," Mr Blessing said. "It creates an incentive for burning down the house."