Sony Kapoor, a former Lehman Brothers investment banker, spoke to EURACTIV about how politicians' fixation on appeasing public anger over bank bail-outs and bonuses has led to lack of vision in clamping down on banks.
Kapoor left Lehman Brothers in 2000 and later set up the think-tank Re-Define, which advises governments and international institutions on reforming financial systems, sustainable development and governance.
He was speaking to EURACTIV's Claire Davenport.
You have been doing the rounds in the EU institutions to talk about financial regulation and structural reform and you have also provided many insights into a financial paradigm shift. But is there really any political will behind a shift from the status quo?
The right response to the crisis should have been 'what role do we want our financial system to perform? What sort of a system do we need for that? How do we get there from where we are now?' But nobody has any particular incentive to take a step back and ask these big but critical questions.
Politicians often do not have a long enough horizon to address fundamental questions, for example, about the role of finance. The proposals out there are a patchwork of reactive responses which merely try address problems specific to this recent crisis. Politicians want to be seen to be doing something to assuage public anger.
There is a push for 'more regulation', whatever that might mean. We need better regulation and a different approach to finance. Merely making regulation more complex would just make it easier to be captured.
What do you mean exactly? Are you talking about regulatory capture, when the smaller lobbyists lose out to the bigger and better resourced ones?
Yes. For example, large banks report regulatory compliance costs in the hundreds of millions of dollars and while they complain, another way of thinking is: 'who else could afford to pay that?' More complex regulation imposes barriers to entry so we have ended up with a non-competitive banking system where current regulation favours big banks over small ones, international over national ones and complex banks over those with simpler structures.
Are there any political figures out there who you think have the right idea?
I know that at the pan-EU level Poul Nyrup Rasmussen came close to a discussion on a paradigm shift last year but since then no, not many politicians I can think of. Sarkozy has made some noises about rethinking capitalism, Merkel has talked about sustainability, Obama has upped the rhetoric against banks and Brown is belatedly talking about the financial system needing to serve society but it is difficult to see that any of them have the right vision.
At a trade union conference organised by ETUI, I heard you speak about a need for narrow banking to prevent a crisis similar to the one we have just experienced. Even though economists appear to agree on paring back banks to smaller entities that do less, the European Commission has been approving bank mergers. Do you think banks will be asked to split in future?
I focused more on the need to actively incorporate diversity into our financial system by having banks of different sizes operating in different markets, fulfilling different but complementary functions and having different capital and compensation structures.
Yes, it would be useful to go back to narrow banking if that were possible. But there will be tremendous resistance from Europe's gigantic and politically powerful universal banks against any such move. I think that breaking big multifunctional institutions into smaller ones the way AT&T was broken into smaller but similar looking competitors is politically more likely than a serious move towards narrow banking.
The reason for that is the structure of financial markets has changed in such a way that many more institutions perform maturity transformations, make markets and create credit: the traditional functions of banks. It would take more serious surgery on market structures to get narrow banking than to break large banks into smaller ones.
Are there any indications from your point of view that the new competition commissioner, Joaquin Almunia, will be true to his word and make financial markets more competitive?
It seems to me, through conversations with officials, that Almunia is going to start looking at banks from a competition perspective, to address the issues of both public subsidies and the size of banks. This has become more important given the mega-mergers and hundreds of billions of state aid that were a characteristic of this crisis.
Investment banking in particular operates as a oligopoly because of the triple problem of very high barriers to entry, a regulatory landscape that is skewed in favour of bigger and more complex banks and the public subsidy that 'too big to fail' institutions enjoy.
I think the competition commissioner will be one of the leading actors improving the banking landscape. I am hopeful, especially since he is widely believed to have done a relatively good job in his last post.
But there were many complaints that the Commission was held hostage by or even pandered to a substantial financial lobby. How do we know Almunia won't do the same?
Yes, this is a very serious problem. Every time I speak to officials about financial policy they complain that they are overwhelmed by bank lobbyists. Ex-MEPs and Commission staff also often go and work for this lobby. If they hear something twenty times and hear the contradictory point of view only once, even a fair person will have a hard time trying not to be influenced.
Another tactic used by lobbyists is to overwhelm people with information. Lobbyists have substantially more resources and can overwhelm officials with studies, names, conferences and events. It does not help that the Commission and Parliament do so little to reach out to the much larger constituency of stakeholders such as unions, civil society organisations, consumer associations and other interest groups such as pension funds.
That is why we at Re-Define are now working with partners to launch a monthly series of high-level meetings between policymakers at the Parliament, Commission and Council on the one hand and non-financial sector groups such as trade unions, consumer groups and wider civil society groups [on the other].
Besides helping organise and convene these sessions we hope to apply our expertise in the financial sector to allow these stakeholders translate the interests of this constituency and society at large into realistic policy proposals which are legislatively useful to the policymakers.
Our primary work to date has been to provide impartial and independent expert advice to governments and international institutions free of any conflict of interest.
What do you make of the EU's proposal for a new European supervisor to warn against macro-prudential risk in the EU, the European Systemic Risk Board (ESRB)?
The large size of the ESRB is likely to be dysfunctional. The dominance of central bankers on the board is more likely to result in the kind of group-think that was a contributing factor to this crisis. And the ESRB lacks real enforcement powers. The combination of these issues is likely to seriously jeopardise its operation vis-à-vis the US proposals, where the systemic risk body will be smaller, more diversely constituted and more powerful.
The European Central Bank is currently concocting reports on systemic risk to inform the new supervisor what it should look out for in the future. What would you add?
Risk does not materialise suddenly in a bust but is built up gradually in boom times. However that is exactly when neither politicians nor regulators have strong incentives to do anything about it. So we need to 'hard-wire' red flags for the build up of systemic risk and incorporate some form of automaticity of corrective measures.
Advances in information technology, ever larger financial institutions, capital account liberalisation and more standardised regulation and risk management practices have reduced the natural diversity of the financial system and amplified intrinsic interconnectedness and hence systemic fragility. The ECB, ESRB and regulators need to recognise this and make a push for more diversity and less interconnectedness.
Do you think lessons have been learned? Will we pay attention to the subtle signs of bust in a boom?
I am afraid these lessons are hard to learn. This is not the first banking crisis but more like the 100th. We need more alarm bells, circuit breakers and red flags and even then we will definitely see another bank crash sooner or, I hope, later.
For example, if the rate of change of asset prices is above a certain level or the degree of short term vs. long term funding changes by a significant level there should be a red flag. The default option should be to take corrective action. It is important to keep discretion so as to not overreact and be flexible and account for the possibility of false alarms. However the philosophy should be to act or explain with a bias towards action.
US President Barack Obama's plans to raise taxes from banks on Wall Street have caused a stir among European banks. A similar tax announcement by Gordon Brown caused investment banks like Goldman Sachs to threaten to jump ship and find another home. Should these tax policies be more selective in their execution?
Just because it was Lehman (whom I incidentally used to work for) not Goldman which went down does not mean that Goldman was not equally complicit in contributing to the crisis, or that it would not have been the trigger for the crisis in another version of history or that it would have survived the crisis without government help as it sometimes claims. Every major bank was complicit.
The UK super bonus tax is smart and politically palatable, especially at a time of record fiscal deficits. If the government succeeds in lowering bonuses as a result of the tax, then they can claim the credit. If it fails, they get the tax revenue. It's a win-win situation. The fact that it is temporary is problematic. What we need is to cap bonuses at a percentage of salary to reduce the asymmetry of compensation which leads to excessive risk taking. A permanent super bonus tax would be a second best move.
The US bank levy is also a politically and economically sound move in terms of making the financial sector pay for its rescue. However the Swedish levy on banks which is permanent (till a target fund level is reached) is better than the US levy because of its longer term nature.
What we need in the end is a combination of 1) bonus caps 2) bank levies and 3) financial transaction taxes, which are complementary measures addressing different aspects of endemic problems in the financial sector. These will enhance financial stability by reducing incentives for excessive risk-taking and help bring about a fairer burden sharing between the financial sector and the real economy in the long term.