Because selective hearing is human nature, everyone from Wall Street Journal editorial writers to Baseline Scenario bloggers has embraced a British regulator's speech that uses a dog snaring a Frisbee to illustrate an argument for simpler financial services regulation.

See, we don't need more examiners, the Journal concluded. A-ha, the big banks must be broken up, the economics blog declared.

Barbara A. Rehm

But Andy Haldane's speech, delivered a month ago at the annual Federal Reserve Bank of Kansas City conference in Jackson Hole, Wyo., was widely misunderstood.

In an interview this week, Haldane, the executive director of financial stability at the Bank of England, made it clear his comprehensive plan includes several, related pieces.

In something of a grand bargain with the industry, Haldane is offering bankers simpler rules and less intrusive oversight in exchange for "structural" reform, higher capital levels and more examiner discretion.

"If some combination of structural reform, plus somewhat tighter, simpler regulation plus an empowered examiner gave a greater deal of assurance" that the next financial crisis could be avoided, "then I think there would be a case for a rather less intrusive intensive approach to supervision," Haldane explained in the interview.

"If I were the CEO of a big bank right now I might well accept that trade-off."

Unlike most U.S. regulators, who generally view their jobs as implementing what Congress enacts, Haldane is actively trying to shape financial services policy. He's basically saying that in the wake of the crisis, policymakers have done "more" and now they must do "better."

A career regulator, Haldane, 45, joined the U.K.'s central bank in 1989 and assumed his current role in 2009. He is a member of the Bank's new Financial Policy Committee, which like our Financial Stability Oversight Council, is supposed to spot systemic risks before they blow up.

His speeches aren't like those of our regulators, where you can simply flip to page 6 and read the conclusion. His "Dog and the Frisbee" remarks at Jackson Hole were actually a 37-page paper complete with charts and data analysis.

His intriguing image — a dog leaping to snatch a Frisbee from the air — is supposed to show that simplicity trumps complexity. The dog isn't using complicated formulas to measure wind speed or the disk's rotation; it's merely running along, keeping an eye on the Frisbee and jumping at the right time.

But instead of keen oversight and well-timed action, too many regulators are focused on a bank's technical compliance with prescriptive rules, according to Haldane. More attention must be paid to broader risks like a company's culture or the sort of business model it's pursuing.

Oversight is too reliant on the first of the three supervisory pillars laid out in the original Basel capital rules back in the late 1980s, he said. Pillar 1 is the rulebook while pillar 2 is oversight and pillar 3 is market discipline.

"We put all our chips on pillar 1. I prefer a more balanced spreading of responsibility between rules, examiners and the market," he said. "I think the way to achieve that rebalance is to start by re-tuning the rules. Unless and until you do that, you haven't got much hope of getting more weight under pillars 2 and 3."

Key among the rules needing a re-tuning: Basel III. And yet Haldane said his speech was not an indictment of the latest capital standards.

"I didn't mean to imply that I thought Basel III was the embodiment of all evil. That wasn't the message. In some respects, it is a real improvement over Basel II," Haldane said.

"Basel III did a good job on the numerator of the capital ratio, the definition of capital, but didn't really make any headway on the denominator, on the risk-weighted assets bit."

Haldane hasn't yet settled on a single solution but insists Basel III can be salvaged. "Even without re-legislating Basel III there is a lot that can be done within it to simplify."

One option is to create a benchmark portfolio against which institutions' risk analysis could be compared.

"The market could reach its own conclusions on who was playing fast and loose and who was being prudent," Haldane said.

But supervisors could go further.

"There are different gradations of intervention," he said. "You could impose floors on the internal models, more overt, more explicit floors below which risk weights could not go. That would be in the spirit of being more interventionalist, perhaps providing more assurance that risk weights weren't being whittled down to nothingness.

"And of course if you wanted to be slightly more interventionalist still, you could think about switching to a standardized approach."

The standardized approach — all banks would assess the riskiness of their assets according to a model designed by regulators — was sidelined in Basel II, which favored allowing banks to use their own internal models.

Beyond risk-weighted capital, Haldane wants a leverage ratio that is higher than the 3% adopted in Basel III.

"I would be loath to share a magic number," he said. "I'd be north of 3, but I am not sure how north of 3 I would be."

Haldane defended his plan to give examiners — the same folks who did not catch or stop the last crisis — more discretion. He thinks countries need more experienced examiners — not more examiners. And he doesn't want them second-guessing every decision bankers make. He wants examiners taking a big, broad view of a bank and how well it's being run.

"For every decision to be a negotiation strikes me as a step far too far for regulation to have reached," he said.

Still, Haldane is worried that the largest banks are just too big.

"I am inclined to think that they might be. I don't know that they are, but I think we are at some risk of that."

His evidence? "The fact that there are very, very few firms internationally that do consolidated risk management across the whole book on a high enough frequency basis suggests to me that there is a question mark about whether some may be too big to manage and if they are too big to manage, rest assured they are too big to supervise," he said. "I don't know if that is the case but I think there is some risk of that."

Haldane expects most of the megabanks to shrink rather than grow.

"One reason they trade at a very significant discount to book is investor concerns that they are not quite sure they know what they are buying. … That is reflected in the price of both the debt and equity for these institutions, and will be a market-disciplining force in having them slim their balance sheets," he said. "So I think directionally that's more likely than a push on to the next height, at least for some banks."

Will bankers accept his grand bargain?

Tougher capital requirements and emboldened examiners have already been accepted by most bankers, but Haldane's third piece — structural reform — is a higher hurdle.

In the U.K. this amounts to "ring-fencing" retail deposits.

Here in the U.S., structural reform is more commonly described as barring commercial banks from investment banking. [Just this week the EU waded into this debate with a report recommending a fence around trading activities.]

Structural reform is needed, Haldane said, because the public policies adopted since the 2008 crisis aren't sufficient to head off the next one. Haldane expects more legislation — not less.

"I don't think many of the problems we've seen over the course of the crisis are fully resolved," he said. "I do not think any of the reforms currently on the statute books, including Dodd-Frank, fully resolve Too Big to Fail.

"I think we may be back around this track and having these ideas in play will be important for giving us somewhere to go next."

Barb Rehm is American Banker's editor at large. She welcomes feedback to her column at Barbara.Rehm@SourceMedia.com. Follow her on Twitter at @barbrehm.

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