Banking on the Dog and the Frisbee
The nuclear and banking industries share a common feature. They are about the most heavily regulated industries on the planet. Some would say that the impact of the financial crisis justifies this status. Given Lehman's and other banking casualties operated pre crisis in this highly regulated space, the question must be asked is regulation alone enough to ensure that banking delivers for all of its stakeholders.11 February 2014
Andy Haldane, Executive Director, Financial Stability, the Bank of England, delivered a speech at the 2012 Jackson Hole Central bank gathering entitled the 'Dog and the Frisbee."
It attempted to answer the question; How could such highly regulated institutions go so badly wrong without detection?
Andy, with his co author Vasileois Madurous said:
"Catching a frisbee is difficult. Doing so successfully requires the catcher to weigh a complex array of physical and atmospheric factors, among them wind speed and frisbee rotation. Were a physicist to write down frisbee-catching as an optimal control problem, they would need to understand and apply Newton’s Law of Gravity.
Yet despite this complexity, catching a frisbee is remarkably common. Casual empiricism reveals that it is not an activity only undertaken by those with a Doctorate in physics. It is a task that an average dog can master. Indeed some, such as border collies, are better at frisbee-catching than humans.
So what is the secret of the dog’s success? The answer, as in many other areas of complex decision-making, is simple. Or rather, it is to keep it simple. For studies have shown that the frisbee-catching dog follows the simplest of rules of thumb: run at a speed so that the angle of gaze to the frisbee remains roughly constant. Humans follow an identical rule of thumb.
Catching a crisis, like catching a frisbee, is difficult. Doing so requires the regulator to weigh a complex array of financial and psychological factors, among them innovation and risk appetite. Were an economist to write down crisis-catching as an optimal control problem, they would probably have to ask a physicist for help.
Yet despite this complexity, efforts to catch the crisis frisbee have continued to escalate. Casual empiricism reveals an ever-growing number of regulators, some with a Doctorate in physics. Ever-larger litters have not, however, obviously improved watchdogs’ frisbee-catching abilities. No regulator had the foresight to predict the financial crisis, although some have since exhibited supernatural powers of hindsight."
The regulatory prescription for addressing the outcome of the crisis has been more regulation. The Dodd-Frank Act in the US has a worthy purpose contained in it's preamble: "to promote the financial stability of the United States by improving accountability and transparency in the financial system, to end ‘‘too big to fail’’, to protect the American taxpayer by ending bailouts, to protect consumers from abusive financial services practices, and for other purposes."
The Dodd Frank Act extends to 848 pages and 370,000 words, requiring an army of lawyers and compliance experts to master it's complexity and translate it into business line instruction manuals which will no doubt contain expanded guidance.
The Basel rules, which form the Banker's Bible began with Basel I extending to 30 pages, Basel II 347 pages, and Basel III 616 pages. The raw material for Basel IV is no doubt being felled in Alpine forests as I write.
The UK Parliamentary Commission on Banking Standards was Chaired by Andrew Tyrie and included Archbishop Justin Welby among its constituents. Even this high quality committee's conclusions and recommendations run to 84 pages and contain over 30,000 words. Should you wish to review the evidence on which the recommendations are based you will need to review a further nine volumes.
According to a House of Commons report the now defunct FSA rule book ran to some 8,800 pages.
Clearly something more than rules and legislation is needed. The very density and complexity of regulation may now be contributing to the problem of achieving effective regulation and the kinds of outcomes and behaviours most right thinking people would want to see.
Banking is a business, run for profit, for the benefit of its shareholders, it is also a public utility providing safe secure money storage and transmission. Society is concerned that the balance of interests between staff, shareholder and customer have been too firmly skewed in favour of staff, and these concerns have been greatly magnified by the levels of executive pay and bonuses where performance at an institutional level has been poor.
The enjoyment of high levels of executive pay in good times and the socialising of losses in bad times is a formula that society will not bear, and nor should it.
The banks themselves are alive to this tension and few leaders of the major players during the crisis are still in post. The new generation have come together to address these concerns and launched a 'Banking Standards Review Board', led by former Financial Times Editor and CBI Director General, Sir Richard Lambert.
The intention is that the new organisation will act as an independent champion for better banking standards in the UK. Participating banks and building societies will commit to a programme of better banking standards, covering both conduct and competence, and will agree to report publicly on their progress on an annual basis.
The proposed first task will be to define standards of good conduct, which will be built on – and in close alignment with – the general principles now being developed by the regulators. The new organisation will then work with individual banks and building societies to help drive these standards into all business activities.
It may take a generation to regain public trust in banking, but in the words of the old Chinese proverb "A journey of a thousand miles starts with one step".
The Banking Standards Review Board can make a valuable contribution in taking those first steps on the journey to rebuilding trust and confidence.
It deserves to be supported and encouraged.