At present, banking regulation is being examined on two fronts. The first is an academic investigation which has come up with the potential for a globally imposed ‘risk tax’. The second is to supplement regulation by improving the culture and behaviour of banks. Both raise important questions on how to address long-standing issues with how to properly regulate the banking industry, especially when considering the systemic risk it poses to the world’s economy.

A new paper from a group of French academics calls into question, through a survey of 220 other papers on systemic risk, the effectiveness of the regulations that have been imposed on the banking sector by Basel III. These include liquidity requirements, higher capital ratios and a stricter definition of capital. These regulations may work to police individual banks, says the paper, but do nothing to identify risk in the system. In addition, the paper also questions Basel III’s approach to determining which banks are systemically important financial institutions (SIFIs). The authors, Sylvain Benoit of the Université Paris Dauphine, Jean-Edouard Colliard, and Christophe Perignon of HEC Paris, and Christophe Hurlin of the University of Orleans, propose a number of alternatives to the current regulatory tools. But in order to identify which ones will work, they suggest a closer working relationship between academics and regulators. One of the authors, Christophe Pérignon, said in an interview on the HEC website: “On the one hand, regulators have access to a wealth of confidential data, but we show their tools are relatively simple. On the other hand, academics have developed much more sophisticated tools and measures using the limited market and public data they have available. It’s time to bring these two sets together through research collaboration.”

The report, "Does danger still lurk in the banking system?," says the economic mechanisms leading to systemic risk have been researched for a long time, so where risks can be found is well understood. But how best to regulate banks and “correct the different market failures leading to systemic risk” has been less well investigated. Many specific tools used by the regulators are “quite new and the extent of their impact is not fully understood yet, neither theoretically nor empirically ...”

The Basel approach, the paper says, is to “compute a measure of all the risks faced by a bank, and infer the minimum capital it needs to keep in order for public funds … to be reasonably safe.” The paper’s alternative approach is to calculate a “global measure of all the systemic externalities imposed by a bank, and charge the bank for the corresponding amount ...” These calculations will include an assessment of balance-sheet and market data, as well as regulators’ assessments of banks’ riskiness. Once this has been assembled, the paper envisages a simple “systemic risk tax or capital surcharge.”

The Banking Standards Board was created a year ago by the seven biggest U.K. lenders in response to calls for improvement by the Parliamentary Commission on Banking Standards, following the scandals over banks manipulating the Libor interest rate and foreign exchange markets. Its first annual review was released to reactions that fell largely in the “what have they been doing for the last 11 months” camp. However, a closer look not only at the board’s assessment of the industry but also at the proposals for future work, shows progress that, while not revolutionary, is steady and thoughtful.

In the press release announcing the review, BSB chair Dame Colette said: “Regulation, although vital for well-functioning markets, simply isn’t the answer to every question. And if we want to see a change in culture and standards of behaviour right across the sector, individual institutions, owners, investors, and the people leading and managing them, all need to step up to the plate.”

The review identifies six themes against which banks must measure themselves. In order to identify these themes, the BSB interviewed the chairmen and CEOs of 10 banks and building societies, as well as junior and middle ranking staff. The BSB wanted to know about: the culture, behaviours and competencies of the banks; what were their priorities in these areas; how did the measure them; how did they reward adherence to them; and how did they know whether staff were adhering to them. The themes are:

Purpose, values, and culture

Culture and conduct

Leadership and key person risk

Incentives and rewards

Challenge and speaking up

Provision, take-up, and effectiveness of staff training and support

Next steps for the BSB include widening the assessment to cover more firms and to canvass the views of a wider group of stakeholders, and “incorporate quantitative approaches enabling firms to benchmark themselves against their peer group.” It appears that there will be cooperation with academia to help the board understand what influences behaviour, as well as to understand whether compliance and regulation are having the proper effect on culture and behaviour.

In addition, the BSB will also be promoting professionalism through a certification regime, as well as, this being the UK, developing voluntary standards. For example, firms could be encouraged to set themselves a particular performance or service standard, to make this commitment public and to be accountable for it.

Senior management facing a higher risk tax if a bank’s culture is not enforced and upheld does not seem too far away.

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