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| Don't ask, don't tell |
| Martin Hutchinson / Oct 30, 2009, 00:56 IST |
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US regulation law: US rules for institutions that are too big to fail need to be transparent and fair. The Treasury’s draft financial services law provides for a new class of systemically important banks which the Federal Reserve regulates more tightly and supports financially. That list should be public, not undisclosed as proposed, and the too-big-to-fail playing field needs to be more obviously level.
The Treasury’s proposed legislation would create a council of financial regulators with the power to identify systemically important banks and other institutions doing financial business. The Fed would then require things like higher capital requirements at these institutions, and could even force them to sell off or close operations deemed systemically risky.
There are two clear problems. First, the legislation proposes that the list of institutions considered too big to fail would not to be disclosed. This begs the question of what criteria will be used by the council to identify them. If done purely by assets, the members of TBTF club could be easily deduced. If subjective criteria were used, that would make it harder to work out which institutions were on the list - but any attempt at secrecy would be doomed because the value of knowing would be potentially high.
That's because inclusion on the list would guarantee support from the government, possibly reducing an institution's funding cost, offset by tighter controls over its business and, in some cases, the possibility of a black mark if regulators were concerned about its solvency.
The second problem arises from giving the Fed too much discretion. Setting aside questions about the US central bank's competence, this would allow similar operations in similar banks to be regulated differently.
JPMorgan, say, might be allowed to undertake credit default swap business while Citigroup was not.
The inter-regulatory council is a sound idea, but its too big to fail recommendations should be made public. The consequences of being so designated should also be both clearly negative and transparent, for example through tighter limits on leverage or extra levies on assets.
That would prevent large banks having an undue funding advantage. In fact it could even encourage the biggest players to shrink or break up - conveniently reducing systemic risk in the banking system.
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