11/07/2012 - 10:43

Good regulation, efficient markets

11/07/2012 - 10:43


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Banking scandals in London and New York contrast with the recent experience of Australia, Canada and a handful of other countries.

Banking scandals in London and New York contrast with the recent experience of Australia, Canada and a handful of other countries.

The global financial markets seem to have no limits on their ability to deliver shocks.

The latest has come out of London, where it emerged that banking group Barclays had been manipulating the London Interbank Offered Rate, known as Libor.

This is crucial because financial markets around the globe use Libor as their reference rate for the pricing of debt securities.

Libor was meant to be beyond question – a pillar of the financial system, against which everything else was referenced.

The unfolding scandal has prompted many to question the curious process for setting Libor, which is based on the interest rates at which major banks in London ‘would’ lend to each other.

The Australian equivalent is BBSW, or the bank bill swap reference rate, which is based on actual transactions, not the hypothetical transactions used in London.

More fundamentally, the Libor scandal adds to growing disenchantment with the international financial system.

It comes just a few years after taxpayers bailed out some of the UK’s largest banks.

And it follows admissions this year by UK banks that they had been misleading business and retail customers over the sale of insurance and derivative products.

The flashpoint for a lot of the anger has been chief executive bonuses; in a handful of cases, such as RBS, banking executives have responded by handing back some or all of their bonuses.

The UK, of course, is not alone.

The US financial system was at the epicentre of the GFC. In that country, prudence and fiduciary responsibility gave way to reckless pursuit of deals and profits.

An even more extreme example was Iceland, where the complete collapse of its banking system has become little more than a footnote – almost a curiosity – in the history of the GFC.

The financial system in southern Europe is also under extreme stress, though that has more to do with government largesse and poor economic management.

Two advanced countries that stand apart are Australia and Canada, and in both cases we have to give credit to the quality of regulation.

It has not always been like this. The commercial property crash of the late 1980s led to massive losses at most Australian banks and several collapses.

That was also a learning experience.

We learnt from groups like Westpac. The bank was a big property lender in its own right but so was its merchant banking arm, Partnership Pacific, and its finance arm, AGC. Together, they almost brought the whole group down.

And who remembers the State Bank of Victoria, brought down by its runaway merchant bank, Tricontinental?

That led to big changes, including the establishment of the Australian Prudential Regulation Authority.

Another defining feature of banking in Australia is the ‘four-pillars’ policy, which blocks mergers of the big four banking groups.

Many times, the big banks wanted approval to pursue a merger, supposedly to make them more competitive on a world stage. 

Thank goodness they were never given that permission. Instead, they have needed to work harder and smarter under the careful gaze of APRA.

This is a prime example of policy makers pushing back against the business lobby and acting in the greater good.

It shows that the interests of a particular business, or a particular sector, are not necessarily the same as the interests of the business community as a whole.

It’s a lesson other jurisdictions have failed to heed. Just look at the legacy of people like Henry Paulsen in the US.

As chief executive of Goldman Sachs, he lobbied successfully for the removal of sensible regulations, and for his troubles was made US treasury secretary in 2006.

He neutered the Securities and Exchange Commission and helped to encourage the excesses that caused the GFC.

If that’s the alternative, then we should be thankful for the career civil servants who run APRA, the Reserve Bank, Treasury and other institutional pillars of Australia’s success.

Disclaimer: I started my working life as a graduate economist in the Commonwealth Treasury and ever since have admired the professionalism and good work of most civil servants.



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