Bank regulation
The
regulation of banks simply does not work and has led to
a serious loss of public credibility in them and of
confidence in their true motives. Almost all of the
problems arise from their activities in securities
markets, rather than traditional banking. The conflicts
of interest and profitability of these fee-earning and
trading activities have been growing, dwarfing the
importance of normal banking income. These factors are
irreconcilable, and a sensible unregulated business
would have decided long ago where its true priorities
lie, so that they may focus on them by ceasing any
conflicting activities.
Government-sponsored regulation therefore fundamentally
alters the competitive picture by legitimising the
natural desire of banks to maximise their financial
power, rather than compete in a free market for customer
business. In this sense, the regulator has become the
tool of the monopolistic banks, because the regulator is
the path to that power.
The
relationship is always presented the other way round. A
good example of this occurred last year, when JP Morgan
Securities Ltd in London was fined $33.32m by the
Financial Services Authority for co-mingling segregated
client funds with the parent bank’s assets.
This is extremely easy for a bank to do, deliberately or
unwittingly. The JPMSL case involved client money held
in connection with futures and options business over a
seven year period, and the balances fluctuated between
$1.9bn and $23bn. These balances were deposited with
JPMSL’s parent, JPMorgan Chase Bank, so in the event of
JPMCB going bust, segregated client funds would become
the property of the liquidator.
According to the FSA statement this “error” was not
deliberate, and was “self-reported”. The implication is
that regulation works so well that even a major banking
organisation confesses to regulatory breaches that might
otherwise have gone undetected.
If
the law had not been changed in the first place to
accommodate the role of the FSA and the legal status of
its regulations, the error would arguably have been
criminal. The confusion initially arises from the
benefits conferred on a bank by its license, which
allows a bank to take someone else’s property onto its
own books and use it for its own benefit. Anyone who
does this without a banking licence clearly commits
fraud, and this must also apply when a bank offers
non-banking services, because its customers by
definition are not in a banking relationship. JPMCB’s
compliance department should have been alive to this
possibility when JPM merged with Chase Bank, which is
when the problem first arose. And the management of
JPMSL’s futures and options business should have thought
through the implications for their customers, rather
than not thinking at all.
But
the question that jumps out from this episode is why did
the FSA itself not detect this gross breach in any of
its routine and ad-hoc inspections from December 2002
onwards, when the breach first occurred? The first
thought in an inspector’s mind should be to examine all
possible conflicts of interest arising between a
subsidiary and its parent. Furthermore, all regulated
entities make periodic returns, so any deposits from
separately licensed subsidiaries should be apparent and
therefore questioned. And while failing in their stated
duties the FSA employs 4,000 full-time staff on an
annual budget of £500m.
The
answer is that the regulator is primarily a government
bureaucracy, and only secondly a watch-dog for the
protection of market participants: the priorities are
firmly in that order. There is no mechanism for placing
a value on the FSA’s role, so it cannot be otherwise. As
such, the FSA can never do its job satisfactorily, and
it will always manage itself in order to satisfy its own
priorities ahead of those of the public. To demonstrate
that it is actually doing the opposite, the FSA relies
on an enormous and complex rule book, with the result
that regulated businesses are required only to comply
with it. Any other business considerations, such as a
primary duty to the customer, come a poor second. Thus,
the creation of a regulatory bureaucracy, responsible
primarily to the political elite and the powerful banks
rather than the markets, has played a large part in the
destruction of traditional business ethics in the UK’s
financial sector.
It
is perhaps ironic that the FSA is unable to understand
its own limitations, but joins in attempts to limit
super-regulation from Europe. The FSA can grasp the
political intent from Berlin and Paris to limit London’s
role as a competitive financial centre, but fails to see
the damage it has wreaked itself at the behest of
British politicians. However, the inability of
regulators to discharge their allotted functions is also
evident in America.
The
US Commodity Futures and Trading Commission was
established to regulate futures and options markets. But
the same rules apply: the CTFC’s primary responsibility
is to the political elite that created it and its own
organisation rather than to the market itself, which is
a secondary consideration in common with all
government-sponsored regulators.
The result is the CTFC does not have a free hand in
policing the market and controlling systemic risks,
which, if the role of the CTFC could be valued, is what
the users of the market would probably require. Even
though the CTFC has just closed a public consultation
period where it has sought the views of all market
participants, it will only enact those changes that do
not conflict with the interests of the powerful vested
interests that govern it. So the wider users of the
market who expect unbiased results will again be most
probably disappointed.
The
relationship between regulators and the powerful
monopolist banks has become one of servants and masters
respectively. The CTFC has recently rubber-stamped an
application by JPMorgan to operate a Comex/Nymex
precious metals storage vault, in a fraction of the time
usually taken for such an authorisation. One is left
wondering whether the speed of processing the
application reflects the desires of the CTFC’s true
masters. But, as Mark Anthony said of Brutus & Co.,
“They are all, all honourable men.” The power of
JPMorgan and its long-running short position in silver
make us vulgar mortals intensely suspicious of their
motives. Can we really assume that they will use the
facility honestly for their customers, and never for
their own ends?
The
granting of this precious metals depository licence
follows the opening of JPM’s precious metal storage
facility in Singapore and its announcement that that it
is prepared to accept gold as loan collateral. On the
face of it, JPM’s management have decided that precious
metals will continue to be a growing business for JPM’s
customers for years to come. But anyone depositing gold
with JPM as collateral should be careful that the loan
agreement stipulates it is held separately by JPM as
custodian, and the same identified bars are to be
returned at the end of the loan.
But
hey, friends, Romans and countrymen, perhaps this
caution is undue, because JPM’s management are all, all
honourable men. And remember, while you may end up out
of pocket, those regulatory boxes will have been well
and truly ticked.
30 March 2011
