It has often been said that no one, starting fresh, would willingly create the regulatory system we have in the United States. It has been noted that we have a Depression-era supervisory system for a 21st Century marketplace.
Although the Dodd-Frank Act was designed, in part, to eliminate these concerns, we must ask whether it accomplishes this objective. Early evidence suggests that the recent crisis may have been wasted; that Dodd-Frank, while well intended, only tinkers with our supervisory and regulatory structure rather than making the hard but needed changes.
In actual fact, our supervisory system remains a maze of special interests, exceptions and nuance that is hard to accept as being appropriate or best-practice. While arguments are made that our system is complex because the world of finance is complex, this is neither a sufficient nor an accurate explanation. Many supervisory and regulatory systems exist that are far less complex than that which we have in the U.S.
It is hard to avoid the conclusion that trust, confidence and transparency are in short supply and that our recent financial reform needs additional repair.
Without a strong, independent supervisor that – in accordance with International Monetary Fund recommendations – is "intrusive, skeptical, proactive, comprehensive, adaptive and conclusive," it is likely that we will, once again, experience regulatory failure. This is not from any malicious intent, but from an inability to say “no” to entrenched interests and our subsidized, too-big-to-fail, systemically important financial institutions.
Some have suggested that our system is designed to be fragmented and unnecessarily complex, thereby promoting narrow, functional and special-interest views of industry and organizational risk. There is some truth to this. For example, the Gramm-Leach-Bliley Act introduced the concept of functional supervision to the regulatory vernacular, as opposed to entity regulation. After Gramm-Leach-Bliley, financial supervisors began to supervise “functional activities” and “processes” as opposed to firm-wide risk and traditional safety and soundness.
In this activity-based regulatory framework – one that remains largely intact – no single regulator has a clear line of sight into excessive risk-taking across an institution or the industry. When safety and soundness concerns arise, the coordination and communication needed to facilitate agreement and understanding is heavily colored by cross-agency politics, in-fighting and turf wars, the practical need to get along with your fellow supervisors, and a profound lack of data and institutional analytics. During the crisis, supervisors were flying blind.
So what path do we take to create a supervisory system that is properly suited to the task at hand? How do we create a system that is able to fulfill its mission, rebuild, and subsequently maintain public trust?
First, dialogue on regulatory reform and supervisory structure must continue. Second, independence is a fundamental criterion for effective financial system supervision; politics must be removed, as far as possible, from the supervisory process – particularly at the SIFIs. Third, transparency, capable personnel, and high ethical standards play a role in avoiding situations where the regulators are unduly close to the regulated ("regulatory capture"). And fourth, data and analytics necessary to properly monitor firm-specific and cross-industry risk pools needs to be a priority.
Perhaps it is time to take a renewed look at our supervisory maze.
What is needed is leadership, accountability and a systemic philosophy that is divorced from the too-big-to-fail doctrine. These qualities are assets that will manifest themselves naturally given the right incentives, proper regulatory realignment, and reconsideration of how big our banks should be. Creating these assets at our financial agencies is the best collateral our financial system can possess, and we should prioritize the task of ensuring that our agencies possess them.
Ultimately, change will happen. The question is whether we make it happen or it is forced upon us.
Thomas Day is SunGard's in-house expert on risk management solutions and policy across the banking sector. He also serves as the vice-chairman of the board for the Professional Risk Managers' International Association.