Supervision not regulation, says SEB's Hansen

In response to the banking crisis and the continuing economic slowdown, governments around the world have rushed to introduce regulatory reforms for the financial sector.

They’re right to do so – but the details of their approach are flawed, argues Lars Hansen, chief risk officer at SEB Life, the life insurance division of Swedish bank SEB, in Stockholm. Instead of concentrating on blanket reforms, board responsibility and higher capital levels, regulators should be taking a lower-level approach, aimed at making good risk management part of individual business units – and followed up with detailed supervision.

“Regulation is such a blunt instrument,” he says. “It’s one size fits all, but different institutions face very different challenges. German savings banks face completely different challenges from Swedish savings banks, which are doing reasonably well. Italian savings banks will probably have huge problems because some of their bond holdings could potentially be worth something completely different.”

As well, he points out, the regulatory decision to lump all banks together and separate them from insurers – represented in the split between the European Banking Authority and the European Insurance and Occupational Pensions Authority, and in similar splits at national level – could be misleading. “We all have different businesses, so we emphasise things differently in investment banking than in retail. Retail banking and insurance probably have more in common, because we have a lot of customer contact. Because we have policyholders and account holders, it’s flesh and blood, whereas the investment banking sector deals in more paper-based products.”

The issue of capital requirements is particularly urgent for SEB and other Swedish banks. Stefan Ingves, governor of the Riksbank, the Swedish central bank, and chair of the Basel Committee on Banking Supervision, said recently that Sweden would impose even higher capital levels on its banks than required under the Basel III capital rules. “Capital requirements for major Swedish banks need to go beyond the requirements of Basel III. The costs of higher capital adequacy requirements are limited and largely private, as opposed to the true economic costs. The advantages in the form of a safer banking system are considerable. A reduced risk of financial crises is good for the real economy, good for taxpayers and also good for the banks’ shareholders,” Ingves said.

Swedish banks would also face a tighter maximum leverage ratio requirement and a floor for risk weightings on mortgage assets, he said in a speech on November 10, 2011. Sweden is not alone – the UK and Switzerland have also announced they will gold-plate the Basel III capital rules in this way. Ingves said that Sweden, like them, had several large and internationally dependent banks, with a high degree of concentration, significant implicit state guarantees, a heavy dependence on market funding, particularly in foreign currency, and low risk weightings. As a result, he said, Sweden was particularly exposed to economic and social costs if problems arose in the banking sector.

The Riksbank has not yet announced the details of the change or its timing – full implementation is due by 2019. But Hansen fears higher capital requirements, if introduced too quickly, could hamper recovery.

“The regulation is very much focussed on more capital at any price,” he says. “I’m not arguing against that, but my big worry is that the regulators are arguing for banks and foreign companies to hold more capital at a time when one really shouldn’t, because the economy might be contracting, which means we will have a capital shortage anyway and this will just add to it.”

Others have warned of the dilemma that overdependence on capital levels as a macroregulatory tool will bring. Adair Turner, chair of the UK Financial Services Authority, pointed out last year that, in a future crisis, a regulator with the power to order changes in capital levels would face a tricky choice. It would either have to allow banks to reduce their capital buffers to produce a countercyclical effect on the wider economy, or compel them to keep capital levels high to preserve market confidence in their soundness – essentially being forced to risk either a banking liquidity crisis or a deeper recession.

“Uncertainty could argue for higher capital levels to mitigate market concerns about solvency and thus help to reduce pressures in funding markets. That is the rationale of the proposals under discussion about increased bank capitalisation across Europe. But a depressed economy argues for letting banks use up their capital and liquidity buffers to support credit growth,” Turner said.

Hansen also has concerns about where regulators’ attentions should be focussed on a practical level – dealing with industry-wide measures such as capital requirements might be distracting them from the hands-on aspect of financial oversight, he says. “We don’t need more regulation in the banking industry, we need supervision,” he says. “We need supervisors who are skilful and have business experience. They need to be in financial institutions. What I would like regulators to do is go out into the business. I think it adds value if they do real supervision, which means they should probably visit the factory a little bit more and get their hands dirty. If they do, two things will happen: first, they will understand the business better, and second, all of a sudden the regulators won’t be something abstract to the business.”

The US Federal Reserve banks tend to carry out many more on-site supervisory visits than European regulators, Hansen says – and they also have the advantage of working within a single regulatory framework.

As well as possibly counterproductive capital requirements, Hansen is also concerned about the increase in required reports to board or senior management level.

“Maybe the industry has brought this on itself,” he says. “But what a nightmare if all board meetings will come to be filled up with regulatory requirements and little time is spent on guiding the chief executive on how to run the business and plan the future for the next five to 10 years. There’ll be no time left for guiding the chief executive in strategy and the difficult questions on how to position oneself in this new and extremely difficult environment.”

Instead, Hansen says, the reporting requirements of regulation should sit within the individual businesses. The regulation is “probably necessary”, he says, but the requirements need to be suitable for the environment in which banks operate.

“I appreciate that we sit on information that is valuable for law enforcers, and so being good citizens we need to co-operate,” he says. “The ideal of having regulation with minimum requirements is crucial because banks and insurance companies are pillars in our social infrastructure. That makes sense, but the question then becomes, who should be required to do what and how should we implement this? On what level? Where I think it starts going wrong is when we start involving senior management in too many things.”