Guest article in the Börsen-Zeitung from 21 June 2024 with Heiner Herkenhoff, CEO of the Association of German Banks.
“When the forest of traffic signs becomes so dense that we can no longer see the path, we are bound to lose our way.” This is BaFin President Mark Branson’s description of the current state of the regulation framework, in which he warns of the need for change. And he’s not the only one calling for financial market regulation to be simplified. At this year’s German Banking Congress in Berlin recently, Federal Chancellor Olaf Schulz explicitly included the banks when he spoke of the urgent need to reduce bureaucracy. But where precisely is action needed?
A forest of rules
One thing we all agree on: effective regulation is the basis for a stable financial system. However, over the last 15 years, the regulatory framework for banks has become unparalleled in its complexity. This complexity is not only due to the consequences of having so many national and European institutions involved in banking regulation and supervision. It is also the result of the sheer quantity of regulatory texts. In some cases, the outcome has been a confusing mass of detailed rules – what Branson referred to as a forest of traffic signs.
A good example is the EU’s macroprudential framework: There are a grand total of five different capital buffers, some of which overlap, making it very difficult to draw clear lines between them. The complexity could be reduced simply by merging individual buffers – without lowering existing capital levels and thus having to compromise on financial stability.
Overall, there are redundancies in many areas of the regulation that do not necessarily lead to greater security. For example, this applies to how the regulation deals with general economic risks. Of course, banks must also be able to withstand severe economic fluctuations. Banking supervisors regularly check banks’ robustness through stress tests. Depending on the outcome, they can take measures that extend as far as imposing additional capital requirements.
However, when setting aside capital to back loans, institutions must take negative economic developments into account in calculating the loss ratio of a loan and determining the probability of default. On top of which there are also the capital buffers mentioned above, such as the countercyclical capital buffer and the systemic risk buffer for residential property loans, which are supposed to provide an additional cushion against cyclical risks. At the end of the day, is it all really worth it?
Excessive regulation has a negative effect on competition for banks, thereby hindering urgently needed growth. But it can also be a source of frustration for bank customers. And this has been observed to occur when it comes to sustainability. The almost incomprehensibly complex regulation is the main reason why customers looking to invest increasingly say they have no interest in sustainable products when asked about their preferences. Many of them are simply not prepared to take on such a complicated bureaucratic burden and, instead, look for investment opportunities elsewhere.
Deterrent effect
One example of this dilemma is the Sustainable Finance Disclosure Regulation (SFDR), with which the EU intended to boost sustainable investments. It stipulates that financial market participants must publish a detailed annual report on the adverse effects of their investment decisions on sustainability factors. However, with 64 different indicators, the regulation is not only too complex, it is also open to misinterpretation. Information about the cumulative adverse effects of all the bank’s financial portfolio management certainly does not help customers who want to invest sustainably, rather, it acts as a deterrent.
In the upcoming review of the regulation, its disclosure requirements must therefore be sensibly relaxed, the number of indicators reduced and, at the same time, made more meaningful. In general, the following should apply: Neither investors nor providers should be subject to sweeping changes, particularly in the investment sector, and especially if they entail new burdens without any recognisable benefits for investors. Unfortunately, precisely this scenario is playing out in the context of the Retail Investment Strategy. The proposed measures would lead to more bureaucracy and would make the sale of securities even more complicated. This stands in direct contrast to the declared aim of the policy, to bring more investors to the capital market.
There is also too much complexity when it comes to supervisory action. For example, is it really necessary to be able to access the individual ESG data of small businesses? Industry values, i.e. proxies, lead to equally good results, but reduce the burden on the economy. “We need to reduce the complexity of our regulation” – we fully endorse this message by Mark Branson. Efficient and smart regulation not only serves to increase the competitiveness of the financial sector, it also benefits customers. We would urge the next European Commission to flick the switch and make the appropriate changes.
