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The regulation of banks simply does not work and has led to a serious
loss of public credibility in them and of confidence in their true motives. Almost
all of the problems arise from their activities in securities markets, rather
than traditional banking. The conflicts of interest and profitability of
these fee-earning and trading activities have been growing, dwarfing the
importance of normal banking income. These factors are irreconcilable, and a
sensible unregulated business would have decided long ago where its true
priorities lie, so that they may focus on them by ceasing any conflicting
activities.
Government-sponsored
regulation therefore fundamentally alters the competitive picture by legitimising the natural desire of banks to maximise their financial power, rather than compete in a
free market for customer business. In this sense, the regulator has become
the tool of the monopolistic banks, because the regulator is the path to that
power.
The relationship is
always presented the other way round. A good example of this occurred last
year, when JP Morgan Securities Ltd in London was fined $33.32m by the
Financial Services Authority for co-mingling segregated client funds with the
parent bank’s assets.
This is extremely easy
for a bank to do, deliberately or unwittingly. The JPMSL case involved client
money held in connection with futures and options business over a seven year
period, and the balances fluctuated between $1.9bn and $23bn. These balances
were deposited with JPMSL’s parent, JPMorgan Chase Bank, so in the
event of JPMCB going bust, segregated client funds would become the property
of the liquidator. According to the FSA statement this “error” was not deliberate, and
was “self-reported”. The implication is that regulation works so
well that even a major banking organisation
confesses to regulatory breaches that might otherwise have gone undetected.
If the law had not been
changed in the first place to accommodate the role of the FSA and the legal
status of its regulations, the error would arguably have been criminal. The
confusion initially arises from the benefits conferred on a bank by its
license, which allows a bank to take someone else’s property onto its
own books and use it for its own benefit. Anyone who does this without a
banking licence clearly commits fraud, and this
must also apply when a bank offers non-banking services, because its
customers by definition are not in a banking relationship. JPMCB’s
compliance department should have been alive to this possibility when JPM
merged with Chase Bank, which is when the problem first arose. And the management
of JPMSL’s futures and options business should have thought through the
implications for their customers, rather than not thinking at all.
But the question that
jumps out from this episode is why did the FSA itself not detect this gross
breach in any of its routine and ad-hoc inspections from December 2002
onwards, when the breach first occurred? The first thought in an
inspector’s mind should be to examine all possible conflicts of
interest arising between a subsidiary and its parent. Furthermore, all
regulated entities make periodic returns, so any deposits from separately
licensed subsidiaries should be apparent and therefore questioned. And while
failing in their stated duties the FSA employs 4,000 full-time staff on an
annual budget of £500m.
The answer is that the
regulator is primarily a government bureaucracy, and only secondly a
watch-dog for the protection of market participants: the priorities are
firmly in that order. There is no mechanism for placing a value on the
FSA’s role, so it cannot be otherwise. As such, the FSA can never do
its job satisfactorily, and it will always manage itself in order to satisfy
its own priorities ahead of those of the public. To demonstrate that it is
actually doing the opposite, the FSA relies on an enormous and complex rule
book, with the result that regulated businesses are required only to comply
with it. Any other business considerations, such as a primary duty to the
customer, come a poor second. Thus, the creation of a regulatory bureaucracy,
responsible primarily to the political elite and the powerful banks rather
than the markets, has played a large part in the destruction of traditional
business ethics in the UK’s financial sector.
It is perhaps ironic
that the FSA is unable to understand its own limitations, but joins in
attempts to limit super-regulation from Europe. The FSA can grasp the
political intent from Berlin and Paris to limit London’s role as a
competitive financial centre, but fails to see the damage it has wreaked itself
at the behest of British politicians. However, the inability of regulators to
discharge their allotted functions is also evident in America.
The US Commodity
Futures and Trading Commission was established to regulate
futures and options markets. But the same rules apply: the CTFC’s
primary responsibility is to the political elite that created it and its own organisation rather than to the market itself, which is a
secondary consideration in common with all government-sponsored regulators.
The result is the
CTFC does not have a free hand in policing the market and controlling
systemic risks, which, if the role of the CTFC could be valued, is what the
users of the market would probably require. Even though the CTFC has just
closed a public consultation period where it has sought the views of all
market participants, it will only enact those changes that do not conflict
with the interests of the powerful vested interests that govern it. So the
wider users of the market who expect unbiased results will again be most
probably disappointed.
The relationship
between regulators and the powerful monopolist banks has become one of
servants and masters respectively. The CTFC has recently rubber-stamped an
application by JPMorgan to operate a Comex/Nymex precious metals storage vault, in a fraction of the
time usually taken for such an authorisation. One
is left wondering whether the speed of processing the application reflects
the desires of the CTFC’s true masters. But, as Mark Anthony said of
Brutus & Co., “They are all, all honourable
men.” The power of JPMorgan and its long-running short position in
silver make us vulgar mortals intensely suspicious of their motives. Can we
really assume that they will use the facility honestly for their customers,
and never for their own ends?
The granting of this precious metals depository licence
follows the opening of JPM’s precious metal storage facility in
Singapore and its announcement that that it is prepared to accept gold as loan
collateral. On the face of it, JPM’s management have
decided that precious metals will continue to be a growing business for
JPM’s customers for years to come. But anyone depositing gold with JPM
as collateral should be careful that the loan agreement stipulates it is held
separately by JPM as custodian, and the same identified bars are to be
returned at the end of the loan.
But hey, friends,
Romans and countrymen, perhaps this caution is undue, because JPM’s
management are all, all honourable men. And remember,
while you may end up out of pocket, those regulatory boxes will have been
well and truly ticked.
Alasdair
McLeod
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