Complexity of financial regulation is exploding. The underlying causes are still not addressed. Instead, regulators want to use technology to keep the inextricable regulatory framework under control – an approach that is doomed to fail.
“The Dog and the Frisbee”: This was the title of a speech by Andrew Haldane. Already a few years ago, the economist of the Bank of England complained about the ever growing complexity of financial market regulation. He used the image of a dog who wants to catch a Frisbee. The exact calculation of the trajectory requires an understanding of complex physical relationships. Nevertheless, a Border Collie is quite good in catching the flying disc. The dog just follows simple rules of thumb.
In his speech, Haldane called for moving away from complex models, and starting to simplify regulation. He pointed out that the capital requirements under Basel I fitted on 30 pages, while Basel III expands over more than 600 pages.
Digital upgrade for regulators
So far, no one seems to have listened to Haldane. Instead of tackling the causes of complexity, the supervisory authorities are now starting to treat the symptoms by using technology. The latest buzzword is “Regtech” – Regulatory Technology. People refer to Regtech when financial companies use IT to deal with ever increasing compliance tasks. But there is also a second meaning. Regtech can be used by regulators themselves, to keep up checking the growing regulatory body.
Now, looking back in history, we see that information technology was the reason financial institutions were able to circumvent regulation in the first place. It is ironic that the regulators today want to resort to technology to keep up with this development – this amounts to “fight fire with fire”. We strongly doubt that this is the way forward.
Institutionalization of complexity
As a starter, such an approach results in quite some costs for the public: Authorities have to invest in new technology.
But much more importantly, doing so will not tackle the underlying problems. Regtech will make regulation even more incomprehensible because it institutionalizes complexity.
The barriers to entry in the financial market are likely to be further raised, whereas the effects on financial stability are more than uncertain. Using technology, authorities won’t be able to master the exploding complexity of regulation – even technologically enhanced regulators will miss the Frisbee.
Instead of digitally upgrade our regulatory bodies, we would better put on much simpler rules. We have to reduce the complexity of the regulatory framework radically. Before investing in Regtech, regulators across the globe should have another look at Haldane’s speech.
- Reflections on banking regulation (a guest post by John Nugée): Ever expanding regulation will not reinstate good behaviors in the world of finance. To the contrary, more and more rules bear the risk that banking becomes a business without any moral basis at all.
- Regulating Fintech: Getting the response right: Recent developments in finance challenge regulators around the world. Fintech companies are on the rise, and it is not clear what kind of new rules are needed. To shed light on these issues, we gave a speech at the GovKnow conference on “The Future of Financial Services – Governance, Regulation and Accountability” in London.