In the five years since the collapse of Lehman Brothers we have not made a lot of progress in terms of the key issues. The banks have fought back vociferously against capital regulations and larger buffers with the result that the changes are insufficiently stringent and in fact now so minor, as to be virtually ineffectual.
Larger buffers are needed and banks need to hold more equity. But there is a broader problem to address about the way in which regulators work. All the regulators are working independently with everyone trying to avoid, or restrict positions in, risky assets. It’s the same problem in the insurance industry. We need to get regulators talking to each other more, to agree what the safe assets are and who is best placed to absorb shocks and hold the risk, because someone has to. Furthermore, we need more synchronised contingency planning. We also need recognition that the regulators can’t see everything and cannot regulate all future financial innovation. We need a clear plan for resolving future crises in which we account for the complex, international structure of financial intermediaries.
To treat the systemic failures in the banking industry that led to the collapse of Lehman Brothers and the financial crisis that followed, we need more transparency to understand where the potential risks in the financial sector are concentrated.
The importation of Basel III like short-term risk management regulations into the insurance industry may have important consequences for the asset allocation of insurers, where they may move away from corporate bonds where they have traditionally among the largest investors. Insurance companies and pension funds are much bigger lenders than the banks. They are the major investors in debt financing for firms.
Changing the culture in banks is going to be near impossible. The banking industry is highly competitive and relying on a cultural change to address these issues will be risky.
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