Can members of a mutual admiration club really tell each other the truth?

I refer to “The progress, pitfalls and persistent challenges of recent regulatory reform” by Sheila C. Bair, former FDIC Chair, and Ricardo R. Delfin, former Executive Director, Systemic Risk Council. It appears in “A force for good: how enlightened finance can restore faith in capitalism” edited by John G. Taft, 2015. 

I agree with many of the recommendations put forward, such as the need for less regulatory complexity, and of a system that could allow for the orderly liquidation of large complex financial institutions. 

But the authors also refer to “the Financial Stability Oversight Council (FSOC), an interagency body made up of the heads of the federal financial regulatory agencies, state regulatory representatives, an independent insurance representative and the head of the new Office of Financial Research. The FSCO is tasked with identifying potentially systemic risks…”

And here I must ask: Is FSCO structured in such a way as to be able to identify systemic risks arising from bad regulations?

Since the inception of the Basel Accord in 1988, the pillar of banking regulations has been credit-risk-weighted equity requirements for banks. These basically translate into offering banks better risk-adjusted returns on equity on what is perceived as safe, than on what is perceived as risky. By this the regulators approved to pay the managers of one of the societies most important retirement accounts, what is generated by means of bank credit, higher commissions for whatever returns coming from activities perceived as safe, or defined by regulators as safe, than from activities perceived as risky. That guarantees an excessive risk aversion that will lead to few jobs and very low retirement incomes for the whole of society.

And if that is not a monstrous systemic risk that has been embedded in current bank regulations what is? I doubt an FSCO, as just another member of the regulator’s mutual admiration club, can do anything about it.

But I might be wrong. Perhaps some “state regulatory representatives” will suddenly ask: Why on earth do our state chartered banks need to hold more equity when lending to our local SMEs and entrepreneurs than when lending to some distant borrowers?