Banking proposals threaten global growth

A new study by the Cato Institute concludes that U.S. and UK domestic and foreign banking proposals may threaten global growth.

The authors, Louise C. Bennetts and Arthur S. Long, say the new measures will not help ward off future financial crises.

Since the financial crisis of 2007-2008 and the Great Recession that followed, regulators worldwide have been attempting to reshape the international financial system so that it may withstand stress more effectively.

The Policy Analysis – The New *Autarky? How U.S. and UK Domestic and Foreign Banking Proposals Threaten Global Growth – evaluated two recent transformative proposals:

  • The ”Foreign Banking Organization” (FBO) proposal of the US Board of Governors of the Federal Reserve System.
  • The “Ring-fencing” plan by the United Kingdom.

* Autarky means isolationism. An autarky is a country that aims to be completely self-sufficient; it does not want to import and export goods and services.

The two banking proposals aim to protect domestic financial systems from the hazards caused by a failure of one or more global, interconnected financial institutions operating within its own national borders.

The authors set out to determine how effective the banking proposals might be in meeting their own stated aims. They also considered what their possible effects might be on the global financial system.

Banking proposals protectionist and parochial

The authors wrote:

”We argue that these measures amount to little more than a mandatory, inefficient shuffling of corporate entities and business units that will not help ward off future financial crises.”

The two proposals, at macro level, undermine global banks’ ability to apportion capital and liquidity in a manner they consider to be the most effective and efficient.

The authors believe the proposals are a sad step in the wrong direction. They threaten to raise the risk of financial instability and undermine economic growth.

They describe the proposals as protectionist, parochial and a “home country first” approach to regulation.

Had these proposal been in place during the financial crisis, outcomes would have been even worse, they believe.

The authors wrote:

”We contend that regulators should instead focus their attention on creating a credible, coordinated resolution process for globally significant firms.”

The report does not single out the USA and UK for focusing too much on protecting their own domestic interests at the cost of the big global picture. Regulators across the world, the authors emphasize, have been looking inward in an attempt to insulate their domestic banking sectors from external shocks.

Conclusion – doing the wrong thing worse than doing nothing

In their conclusion the authors quote Andrew Bailey, the deputy governor of the United Kingdom’s new Prudential Regulatory Authority, in a recent speech to the British Bankers Association.

Bailey said:

“We should not design the world as if fragmentation and balkanization are inevitably always likely to be with us.”

Bennetts and Long believe that is exactly what the US’ FBO and UK’s ring-fencing do. They believe the US Federal Reserve and the UK Parliament are succumbing to the politician’s logic that something needs to be seen to be done because that is what a vociferous public expects.

The authors end the report with the following comment:

“Given the clear adverse effects on the availability of credit, global capital flows, and the world economy that will flow from the FBO proposal and the ring-fencing plan, we believe it to be far better policy to heed the contrarian advice that ‘doing the wrong thing is worse than doing nothing.”