Davos Clash a Sign of Tougher Reform

The clash between bankers and regulators in Davos generated more heat than light. But although the debate demonstrated why it is so hard to achieve consensus on financial reform, it also provided a few hints about the eventual outcome. In short, the odds of tougher regulatory reform have increased, but look for a more a la carte approach rather than a globally uniform package of measures.

Bankers arrived at the World Economic Forum last week determined to push back hard against fresh efforts to tighten curbs on the industry, most notably the Obama administration’s surprise proposal unveiled a few days earlier to bar banks from proprietary trading and owning hedge funds and private equity funds.

Perhaps not surprisingly, it was European banks rather than their American counterparts that led the charge. Robert Diamond Jr., the president of Barclays and head of its Barclays Capital investment bank, attacked the whole premise behind the too-big-to-fail debate and warned that efforts to curb the size of banks would undermine growth. “If you say that large is bad and we move to narrow banks, the impact on jobs and the global economy will be very negative,” he told a panel on regulatory reform.

Even proposals to raise capital and liquidity requirements, an area on which G-20 governments are broadly agreed, drew some fire. Deutsche Bank CEO Josef Ackermann cautioned that raising requirements too high could frustrate attempts to reopen securitization markets, which is vital to restoring financial and economic health. “If people think we are going to move from a market-based system to a bank-based system where we take the loans on our books, they are mistaken,” he said.

Regulators and politicians gave as good as they got. There are still significant differences between various countries’s proposals that need to be narrowed, they acknowledged, but all are agreed that letting banks go back to business as usual isn't an option. “It’s absolutely clear that far-reaching fundamental reform of the financial system is needed,” Hector Sants, chief executive of the U.K.’s Financial Services Authority, told a luncheon crowd organized by his old employer, Credit Suisse. “And it’s not at all clear that the majority of the industry recognizes that.”

Both sides agreed to tone down the rhetoric at a rare two-hour meeting on Saturday, which involved the likes of Ackermann, HSBC chairman Stephen Green, Bank of America CEO Brian Moynihan, Financial Stability Board chairman Mario Draghi, European Central Bank president Jean-Claude Trichet and Barney Frank, the chairman of the House Financial Services Committee. Diamond and Ackermann even expressed support for a global tax to help fund any future bank bailouts. Crucial decisions need to be taken on two fronts in coming months, though, and both sides are digging in for a tough fight.

The first reform agenda covers tighter capital and liquidity requirements. The Basel Committee on Banking Supervision has drafted several proposed rule changes in recent months, including a measure that will force big banks to triple the capital backing their securities trading operations. The committee will run tests of the impact of the new rules on banks in the first half of this year and aims to adopt final rules by the end of the year. Bankers are already warning that the combined effect of the rule changes will be to raise capital requirements to onerous levels, which would impede attempts to spur lending and economic growth.

Most big banks have boosted their tier one capital over the past year or so by a percentage point or two, to 8 percent or more of assets, and they are lobbying to ensure that the final capital rules come in as close as possible to current levels. Regulators are likely to aim somewhat higher but give banks several years to reach any new standards, so as not to put a damper on lending.

An even tougher battle looms over proposals to rein in the size and activities of big banks. Most European countries have a tradition of universal banking, or combining commercial lending and investment banking under one roof, and some officials were scornful of President Obama’s proposal, which some have simplistically characterized as a return to the Glass-Steagall era. “It’s an absolute error” that is going to “kill the New York market,” said one senior European official who spoke on condition of anonymity. But Adair Turner, the chairman of the U.K. FSA, suggested possible ways of achieving the Obama plan’s objectives by regulating the volume of trading by big banks.

And Philip Hildebrand, president of the Swiss National Bank, welcomed the political signal sent by the U.S. proposal, saying it would give “an impetus to the reform process.”

There’s a growing acceptance that major countries will not all adopt the same list of reform measures. Making sure that differences are kept to a minimum and don’t create huge gaps that global banks can exploit is the task of the FSB, which groups regulators from all G-20 countries. But the prospects of tough reform look better now than they have since the crisis erupted.

“The banks are a very powerful lobby. You’ve got to mobilize your public opinion if you want to take them on,” says Barry Eichengreen, an economics professor at the University of California, Berkeley. With the Obama proposal, he adds, “maybe we’ve started to see that.”

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