New research suggests that moves to simplify bank regulation in the United States and Britain could inadvertently diminish the safety of the financial system. The study, set to be presented to top central bankers at the European Central Bank’s Sintra conference next week, challenges the widespread push to reduce regulatory ‘red tape’. It posits that complexity within financial rules often serves a crucial role by making them more difficult for lenders to circumvent, thereby enhancing stability rather than hindering it.
Researchers, including Professor Mariassunta Giannetti from the Stockholm School of Economics, demonstrated that even seemingly tough but simpler regulations are more susceptible to being ‘gamed’. Banks could shift risks elsewhere within the system, potentially creating new vulnerabilities. The authors specifically warned that the ‘U.S. rollback risks going too far’, noting that Britain is also gradually moving in a similar direction. This trend runs contrary to a broader deregulatory movement in both nations, where easing supervision and capital requirements aims to foster lending and innovation, and post-financial crisis constraints like ‘ring-fencing’ are being reviewed for greater bank flexibility.
In contrast, policymakers in the European Union are attempting to streamline their rulebook without reducing overall capital requirements. The study suggests this balance aligns with their findings, provided that simplification doesn’t remove crucial ‘load-bearing’ elements essential for rule effectiveness. Switzerland’s tightened regulatory stance following the 2023 collapse of Credit Suisse also reflects this pattern, combining strict requirements with sufficient detail to limit loopholes. However, the authors caution that their results are based on market data from listed financial institutions, meaning they may not fully capture risks in less-regulated sectors such as private credit or private equity-backed lending.
