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Does it pay to obey? Over-complying with financial regulations as a deliberate strategy

Political economist Prof Andrew Walter talks about approaches to financial regulation in the long aftermath to the Global Financial Crisis, and what happens when banks over-comply with the new rules. Presented by Lynne Haultain.

"This is where the fundamental issues of thing like capital requirements, leverage requirements, liquidity requirements, the fundamental core of what needs to be done in response to the crisis, this is where it's very tough to sell the message effectively to voters." -- Prof Andrew Walter




Prof Andrew Walter
Prof Andrew Walter

Andrew Walter specialises in International Political Economy and joined the University of Melbourne as Professor of International Relations in 2012. His previous academic posts were at Oxford University and most recently at the London School of Economics and Political Science, where he was also academic director of the TRIUM Global Executive MBA Program. He has been a visiting professor at universities across the globe, including Canada, Japan and America.

Andrew sits on the editorial board of the Review of International Studies, the journal of the British International Studies Association. He has co-authored and published many titles including East Asian Capitalism: Diversity, Change & Continuity, Analysing the Global Political Economy, Governing Finance: East Asia's Adoption of International Standards, and China, the United States and Global Order.

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Host: Lynne Haultain
Producers: Eric van Bemmel, Kelvin Param
Audio Engineer: Gavin Nebauer
Voiceover: Nerissa Hannink
Series Creators: Kelvin Param and Eric van Bemmel

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VOICEOVER 

 


This is Up Close, the research talk show from the University of Melbourne, Australia.

LYNNE HAULTAIN
Hi, I'm Lynne Haultain. Thanks for joining us. The global financial crisis that reached its climax in 2008 still looms large in our memories, and for many of us it looked like a failure of regulation. Banks and financiers were very arrogant, too big to fail, regulations failed to protect us and we all paid the price. In the aftermath there have been calls from a number of quarters for tighter control, greater conservatism in how banks and other financial institutions operate.
The Basel Accord, which has now been through three iterations, is the main channel for agreement on international financial regulation and it's principally about levelling the playing field, trying through various standards to ensure that lenders, borrowers and traders can have confidence that the other parties they're dealing with are working within similar, if not the same, framework. Basel has generally been seen as a minimum requirement.
So what's going on when a number of countries would appear to be over-complying and more than meeting the Basel requirements? Does that make for a more robust system, capable of preventing or at least containing any future shocks? Is over-compliance necessarily a good thing?
Andrew Walter is a political economist and Professor of International Relations in the school of Social and Political Sciences at the University of Melbourne. He's also a senior fellow in the Melbourne School of Government and he's been looking at cases of over-compliance, why they occur and what impact that might have. He's looked at a number of examples in a 2014 article entitled The political economy of post-crisis regulatory response: why does 'over-compliance' vary? Professor Walter, many thanks for joining us on Up Close.

ANDREW WALTER
A pleasure to be here. Thanks Lynne.

LYNNE HAULTAIN
As you said in your article Andrew, failure to comply, failure to meet the minimum standard under Basel has had a lot more attention than over-compliance, and it would seem to me that understanding why people fail to comply is fairly straightforward. They'd see it as red-tape, they'd see it as curtailing their competitiveness or their returns on investment. Is that really the issue as to why people don't comply, the failure to?

ANDREW WALTER
Well I think we need to go back a little bit to the beginnings of the Basel process and it really came out of the Latin American debt crises of the 1980s when particularly American banks but also British and some European banks found themselves in a sense holding a lot of non-performing loans on their balance sheets and regulators, again particularly in the United States and United Kingdom felt that their banks were tottering, in danger of failure and these banks were too large and the costs of bailing them out were looming. And therefore there was a requirement at the time to raise levels of so-called capital within these banks in order to shore them up and to prevent their collapse and potential further bail-outs of other banks by taxpayers.
That created a competitiveness problem because if you raise levels of regulation, if you make banks safer in one country, like the United States, that creates objections on the part of the bankers primarily and potentially the people who invest in them and provide credit to them, and also the people who borrow from them, the big industrial firms say, that by raising the stringency of regulation in the United States, that's making them less competitive in international banking, vis-à-vis competitors, at the time competitors primarily in Japan but also in places like France.

LYNNE HAULTAIN
So that's why institutions were looking not to comply. And then there was actually a movement towards convergence and to compliance.

ANDREW WALTER
Yes. So what happened was the Brits and the Americans got together. They raised minimum capital requirements bilaterally in agreement in 1987 and said to all of the other members of the Basel Committee who were only really essentially at that time 10 to 12 countries, primarily North American and European, that if you don't meet these minimum standards and raise them and particularly the Japanese banks out there, if you don't raise your levels of capitalisation, you won't be allowed to operate in London and New York, the two most important financial centres in the world. So deep concern with under-compliance on the part of the United States and Britain, mainly by Japanese banks but also French banks at the time. 

LYNNE HAULTAIN
So why has there been over-compliance? What advantage does that offer?

ANDREW WALTER
Well there always has been. In a number of sub-Saharan African countries for example, they decided to go well beyond this minimum so called Basel I Agreement of holding or setting aside eight per cent of their balance sheet as equity or something that looks like equity as a proportion of their total assets. A lot of African countries went well beyond this and required minimum capital well in excess of this, but of course their banks are weak, their economy is highly volatile and so on. So the risk in the financial sector was more substantial in different jurisdictions.
So there always was over-compliance in the system but primarily concentrated in the developing world from the 1990s. Increasingly what we're seeing though is a number of jurisdictions in response to the global financial crisis who didn't get what they wanted out of the latest iteration of the Basel process, Basel III, agreed in 2010, so a couple of years on after the beginning of the global financial crisis. Britain, Switzerland, a few others, Singapore, Hong Kong in Asia, all saying that essentially Basel III is not enough and what's required is something that goes substantially beyond this. Their banks need to be safer. There needs to be signals sent that their jurisdiction is relatively safe and relatively stringently regulated compared to others.

LYNNE HAULTAIN
And the motivation for that is?

ANDREW WALTER
Well potentially it's a response to things like voter anger, the most costly crisis in nearly 100 years. Think about Switzerland. UBS, the biggest bank in Switzerland, fails catastrophically, has to be bailed out by Switzerland, not a particularly large country. Hitherto a country with a reputation for prudence, they make Swiss watches, your money is safe in Swiss banks. Indeed it may be secret in Swiss banks historically. So it's safe, secret, this is where people put their wealth, a place that people can trust. All of a sudden the biggest bank in Switzerland fails. Why? Because it's dabbling in what became seen as very risky, so-called toxic assets and trading activities that were highly risky, highly leveraged. When UBS fails it creates this enormous backlash, political backlash, in Switzerland against some of these banks. The response on the part of Swiss regulators is we're in danger here of losing our reputation for sanctity, for prudence and all these…

LYNNE HAULTAIN
Security.

ANDREW WALTER
… things, security. Basel III doesn't look strong enough. In fact we need to signal, particularly vis-à-vis other places in Europe like Germany and France who are looking reluctant even to go along with Basel III, the minimum sort of upgrading and increased stringency that's added on to Basel II, we need to go beyond this just to signal. It's a signal that we're safer than you.

LYNNE HAULTAIN
So is it marketing?

ANDREW WALTER
It's partly marketing and I think indeed you might say that what has become known in the industry and among regulators as the so-called Swiss finish, the two biggest banks in Switzerland, UBS and Credit Suisse are now required to hold a minimum capital to asset ratio of 19 per cent.

LYNNE HAULTAIN
So that's a very substantial increase from, say eight per cent.

ANDREW WALTER
Yes, it's a substantial increase from eight per cent, in fact they've tightened up various definitions so that the previous minimum eight per cent is not comparable to the new 19 per cent. Eight per cent under the new rules would actually be more stringent than the old eight per cent. They've also, the Swiss, said not only this, we'll go beyond - well, effectively a minimum now of nine and a half per cent. We will add on almost another 10 per cent to this effective new global minimum. Does that mean that Swiss banks and the bigger Swiss banks are now far less leveraged than their global counterparts? No, not at all because there's one other twist to this particular ratio, capital to total assets is a simplification, it's actually total capital to risk-weighted assets and the risk-weightings among the most sophisticated banks in the world are now done by the banks themselves, that is the banks use internal models to work out the relative riskiness of different assets, whether it's a loan to a corporation, an asset that they're trading on an hour to hour basis. They set aside different amounts of capital in effect, according to the relative riskiness of assets on the balance sheet. The way that they do this, they use a lot of sophisticated mathematics, models, algorithms to generate using past data the relative riskiness of assets. 
So they're weighting their balance sheet and therefore potentially the fear is among a number of regulators and commentators, we're creating and have created and are heavily reliant now on a system which in effect delegates regulation to the banks themselves and allows them to get around what looks like a highly stringent rule in Switzerland. Switzerland still has some of the most leveraged banks in the world. So the Swiss Finish may not be all it's made to be.

LYNNE HAULTAIN
Which is interesting on a number of levels but there is no way then of comparing like with like if that's the case, if the banks are dictating their own terms in terms of their risk.

ANDREW WALTER
Indeed. The Basel Committee and a number of other regulatory agencies around the world, the Bank of England have done studies, sometimes exactly the same risk so exactly the same type of corporate loan has a different risk weighting among similar banks to the tune of sometimes hundreds of times. Essentially the critics of this system, of risk waiting, see this as a system that's right for gaming by the most sophisticated banks in the world who are always one, two, maybe three or four steps ahead of the regulators. So what can look like headline over-compliance in the case of Switzerland say, or even the United Kingdom which has a more modest version of over-compliance on minimum capital requirements for its so-called big ring-fenced banks, potentially can be gained by banks.

LYNNE HAULTAIN
I'm Lynne Haultain and you're listening to Up Close. In this episode I'm discussing the impact of over-compliance in international banking regulation with political economist, Professor Andrew Walter. Professor Walter, you mentioned Switzerland and that's one of the countries that you look at in this paper, together with the US and China, and in all three cases you're showing that extraordinary interplay between the domestic financial structures that exist in each of those three jurisdictions, the power of those local institutions, the banks and the financiers, and the prevailing politics. All three are quite intriguing in very different ways.
Let's take a look at the US because they're particularly - we're seeing this tremendous tension between the interests who are looking for greater control, greater certainty in the banking sector, I'm thinking particularly here of organisations on the right side of politics, the Tea Party for example, and on the other side we have the banks. We have Wall Street who are pushing against any great astringency in regulation. Where do they sit now in terms of over-compliance?

ANDREW WALTER
There was a lot of concern in places like China and indeed right throughout the world that the United States wouldn't even implement Basel III, which of course - the United States has always been by far the most important player within the Basel Committee. There are a number of others, the United States always has needed the United Kingdom in particular, with London as the most important global financial centre, to go along with it. The United States has always been the first among equals in this relatively small elite club of regulators.
The United States didn't implement Basel II before the global financial crisis, even though it played an absolutely instrumental role in re-shaping Basel I into a new Basel II which gave a lot of discretion to banks, the sophisticated banks in terms of using these internal models to measure their own risk on their own balance sheets. So the United States then subsequently, after agreeing to Basel II in 2004, decides not to implement it. The EU for example, implements Basel right across the board for all depository institutions, so all banks in the European Union. The United States has now decided to implement Basel III. The Chinese were very worried that they wouldn't because of course China discovered during the global financial crisis that it had become deeply dependent on financial stability, both in the United States and Europe.
So the Chinese are saying in this committee of which they're now a member from 2009, you Americans and you Europeans really have to get your act together and re-regulate in ways that protect not only yourselves but also us, and in particular we're worried about America because your domestic political process, the push-back from banks, the push-back from other interests, we all know that the United States congress is very open to money politics, to lobbying and so on. So deep concern that the Americans would fail to implement it. In fact, now they've come along and said, we'll implement Basel III but only for the top 17 banks. 

LYNNE HAULTAIN
So where is it then in terms of that tension between Wall Street and for example, the Tea Party, or the particular element of American politics which are deeply concerned about the sort of destabilisation that we saw during that particularly difficult period around 2008.

ANDREW WALTER
Yes, so we've had an interesting coalition of interests and opposition to the banks in places like the United States. So we've got the Occupy Wall Street movement on the broad left I guess, which has now largely faded away.  The Tea Party, interestingly from the right, a more libertarian minded, small business but a long anti-Wall Street, anti-New York tradition in American politics which has been tapped into by the Tea Party and which has been more persistent and indeed more sustained in its efforts, particularly to tackle what they perceive as an unholy alliance between Capitol Hill, Washington and the White House, and Wall Street. So this nexus that they perceive to be deeply engrained in both parties, Democrat and Republicans in the United States, and a fear that if they didn't continue to lobby for breaking up in many cases the big banks, that's what a lot of Tea Party members want, that actually the bank would regroup after the crisis reached its depths in September 2008, regroup to oppose Dodd-Frank, the biggest piece of financial regulation legislation in the US since 1933. So they've kept the pressure up on banks. 
So I think there are some interesting configurations in American politics, alliances between regulators who typically - or at least now in certain parts of the very fragmented American regulatory system more conservative than others, the Deposit Insurance Corporation, one of the key regulatory agencies in the United States for example, pretty aligned with those in society more broadly who want the big banks in particular to be reined in, to be less risky and to put the American taxpayer in particular at less risk.

LYNNE HAULTAIN
Who's winning?

ANDREW WALTER
Arguably both sides at the moment. So on certain pieces of legislation the banks have clearly been able to push back. However there are things like the Volcker Rule, which is not a re-introduction of the previous system in place since the Great Depression lasting until 1999, the Glass-Steagall Act which effectively separated so-called commercial or plain vanilla banking from the really risky so-called casino banking, the trading world of Goldman Sachs, Morgan Stanley, Merrill Lynch and so on. That went when Glass-Steagall was repealed in 1999. 
So we've now got the Volcker Rule which will over the next couple of years stop banks from engaging in so-called proprietary trading, the sort of thing which led to the catastrophic London Whale incident, where J.P. Morgan lost $6billion or a bit more of their own money by trading in London. So what we're seeing is a lot of back and forth here. Some victories for the banks but increasingly over the last year or two, some victories I think for those relatively conservative regulators that are saying in some areas, America needs to push beyond Basel III and there are a couple of quite technical areas to do with liquidity requirements and so on. One of the most obvious and most interesting developments I think, America deciding that it will require again only of its largest banks, a so-called higher minimum simple leverage ratio of five per cent for the biggest banks and the leverage ratio is essentially capital to non-risk weighted assets. That will prevent, in the eyes of the FDIC, the Deposit Insurance Corporation, as well as others in Congress, banks from gaining the system by using internal risk weighting models to get around the increased stringency of Basel III.

LYNNE HAULTAIN
And we'll wait and see whether or not that's actually the case.

ANDREW WALTER
Yes, we'll wait and see. 

LYNNE HAULTAIN
The other case study that you looked at was China, which as you've mentioned is an intriguing one in that it's an emerging banking and financial player in global terms, and keen clearly to establish itself as a big one, but also as you describe, recognised at the time of that crisis, how vulnerable it was. So given that it is newly emerging and only now beginning to really play on the international scene in terms of these sorts of service provisions, where does it stand on over-compliance?

ANDREW WALTER
Well, China is a fascinating case I think. A few years before the global financial crisis, China was still seen by members of the Basel Committee as essentially backwards, a largely state controlled financial system, still heavy with big state owned banks or state dominated, used by the Chinese government as the essential mechanism by which the fiscal stimulus pushed enormous amounts of new credits through the Chinese economy.

LYNNE HAULTAIN
And that was post-crisis.

ANDREW WALTER
Yes, so the so-called fiscal stimulus in China at the end of 2008 was essentially driven by telling the banks to go out and lend like crazy, in particular for infrastructure projects under the auspices largely of local government borrowing platforms and they may have got themselves into some trouble there. I think particularly with the new leadership there's growing concern that that response to the global financial crisis may unfortunately have had a dark side and may be storing up new problems, new non-performing loan problems in the Chinese financial system, such as they had in the 1990s, in which they subsequently cleaned up at enormous cost. So therefore over-compliance in China, which has only very recently emerged, in 2009, 2010, may be in part a response to those growing concerns, particularly in the new leadership, that there may be real hidden problems on the big state owned banks' balance sheets in particular. So therefore again Basel III capital requirements may just not be enough. 
There are also interesting international dimensions for China which I talk about a bit in the paper. China's only let in to this new committee in May 2009, of course after the crisis it's now also a member of the G20 Leaders' forum from November 2008. So China is now sitting at these key tables and the G20 is telling the Basel Committee, you guys have messed up badly. You didn't prevent the crisis, the worst crisis in nearly 100 years. Get your act together or you're irrelevant, we're going to find something new. China is of course now sitting at the table and so part of the agreement for Basel III in 2010, but because it's very concerned about America not necessarily implementing, [it] doesn't want to give America an excuse not to implement because China is not forging ahead with implementation, think about Kyoto and the concerns generated in places like America and Australia and elsewhere. Well, if we sign up to minimum standards in Kyoto, emissions reductions, any efforts on our part are going to be swamped by the Chinese if they don't do anything.
So I think the Chinese have one eye on this implementation concern in the United States. They also of course are starting to engage in what some would see as a bit of hubris after the crisis, we survived, this is not a global financial crisis, this is an American and a European crisis. Chinese banks are fine. In fact they're so fine that we can go beyond Basel. We're stronger than you. Again, there's a bit of a Swiss macho bit I think in part going on here. They subsequently find actually this is tough and what they've promised may not be achievable so they start to backtrack a bit on those earlier macho tendencies towards over-compliance.

LYNNE HAULTAIN
It's a fascinating picture because the case studies that you chose to highlight also represent, as we've discussed, the three very, very strikingly different political dimensions. We have direct democracy as best expressed in Switzerland, we've got that interesting interplay between commercial and political interests in the US and then we have a state owned pretty much banking sector in China.

ANDREW WALTER
It's largely an authoritarian political system which one would think could essentially do what it wanted to but it can't. China is - it's not a democracy either in the Swiss or American sense but it's nevertheless an authoritarian regime which has a lot of powerful interests pushing against this argument. If you're a big state owned enterprise and need cheap capital to survive from big state owned banks, do you want them to be increasingly stringent in their credit risk analysis, increasingly constrained by over-zealous regulators. So you can imagine the coalition of interests and, of course, very different again to Switzerland and the United States. Big state owned firms of course have important connections to the political system. This is widely known, not news to anyone including people in China.
So those vested interests have been pushing back strongly against those more conservative minded regulators. So we get something approximating the kind of political tussle over regulatory reforms since the crisis in China that we do in more classical democracies.

LYNNE HAULTAIN

You're listening to Up Close. I'm Lynne Haultain. In this episode we're looking at the reality and impact of over-complying with international banking standards under the Basel Accord with political economist Professor Andrew Walter. 
Andrew, let's look at the consequences of this over-compliance, and as you said some of it might be described as such but isn't necessarily because there are ways and means of manipulating the outcomes, but what do the variations mean, about the whole project of international regulation of banking, is it possible?

ANDREW WALTER
Well, it's very difficult clearly. It always has been and it's just getting more and more difficult as the complexity of finance continues to increase over time and as new countries come into the system, China with a relatively unsophisticated, traditional, state owned banking system, compared to the complexity of finance in places like London and New York and a few other parts of the world.
So choosing a one size fits all policy is extraordinarily difficult. In fact you might think of it as a kind of utopian venture. In the past, that utopian problem has been got around by the sheer dominance of the two big countries and the system of the United States and the United Kingdom, but the days are gone when the UK and the United States could essentially tell the Japanese and French and a few others either to converge on their bilateral agreements, which formed the basis of Basel I, or else you just can't operate in the city of London and the city of New York if you're, say a Japanese bank subsidiary, or a branch in these jurisdictions. Those days are gone. So London and New York remain the most important financial centres but particularly and in power and negotiation terms, the United States and the United Kingdom have in a sense lost that ability to coerce other countries into converging, at least in principle and in form if not necessarily the reality, the underlying reality of compliance on those British and American standards. 
That's also been made worse by the fact that the domestic politics within Britain and within the United States has become so fractious over financial regulation since the global financial crisis that we get these titanic ongoing struggles. So the crisis is in that sense far from over. We've not yet got a resolution. We've not yet reached an equilibrium of financial regulatory response to the crisis in these most important countries because we still have this ongoing struggle between those people that say Basel III is not enough, we need to cut through all this complexity and go for much more simplicity, the banks say that Basel III and even worse, the various forms of over-compliance that are being advocated by regulatory conservatives in places like the US, Switzerland and elsewhere, will kill the banking system.
I was in London just a month ago talking to some bankers and they said clearly the government doesn't want the City of London to be a global financial centre anymore. You know, simple as that. All of this piling on top of an already onerous Basel III process means that the government just doesn't want banks, global banks, to operate here anymore in any serious way. 

LYNNE HAULTAIN
So that's sound like they're hunkering down. This is an extremely defensive position. Provocative.

ANDREW WALTER
Yes it is but it's also a marketing position, it's also a deeply political strategy. There are many people out there, some pretty important names in the field of finance, Anat Admati and her colleagues, Stanford and elsewhere, Andy Haldane, the executive director for financial stability at the Bank of England, arguing that Basel III is far from enough. Indeed the head of the British Independent Commission on Banking which proposed that British banks, the  biggest ones, go beyond Basel III and meet a minimum so-called 10 per cent core capital ratio, three per cent above the Basel III minimum, has come out publically since and said actually the best number would be 20 per cent, not 10 per cent. So actually British banks should be the biggest ones to prevent risk to taxpayers, such as was realised in 2008. We need to go way beyond Basel III and the current British rules are not enough. The banks think of course…

LYNNE HAULTAIN
That will kill the golden goose.

ANDREW WALTER
[It would] kill them, it's socialism and so there's this ongoing political slanging match, with the banks saying that the consequences of over-compliance, particularly of that very, very ambitious variety is not only bad for them but also bad for all of the rest of us, bad for the domestic economy, bad for employment growth, and we're not living in a very robust global economy anymore. Economies like Britain and the United States are still continuing to recover from this massive economic shock. So the banks have a lot of leverage by making those kinds of arguments and saying to politicians effectively, in the next election do you want to be the people who've basically provided over a continuing weak recovery and still high levels of unemployment?

LYNNE HAULTAIN
Profound questions indeed but what does it mean for you and me, this instability and this anxiety on so many different planes in so many different parts of the world?

ANDREW WALTER
Well it means different things of course. In the short run, if the banks were right, it could mean slow growth, high unemployment, potentially falling house prices, all of these things. So if regulatory stringency were ramped up to the point where banks stop lending to relatively risky customers and were constrained in the amount of credit that they were creating in the economy, the consequences could be catastrophic. So there's an ongoing debate about whether those real economic effects of additional levels of stringency are real or simply something dreamed up by banks' lobby groups. 
Again, there's quite a lot of work being done. The Bank of England has done work which again suggests that something like 20 per cent, so nearly three times what's required by Basel III, would be consistent with very, very modest losses in growth and employment that almost no one would actually perceive. So no substantive real economic effects but that it would deliver such a higher degree of financial stability that we enjoyed during the classic Bretton Woods period two and a half decades after World War II where we essentially had no major banking crises in the western world. 
So if we could go back to that, a relative period of high economic growth, of financial stability, we don't go back to that but there's a question about how much we're willing to trade off for growth and jobs today, versus what's the price we're willing to pay, in other words in order to avoid another so-called global financial crisis?

LYNNE HAULTAIN
I suppose the question is, is there the environment for a reasonable debate about this? From what you've described it would seem that the various parties are in profound opposition and deeply entrenched in their views.

ANDREW WALTER
They are because there are very powerful interests of course at stake here. I'm inclined to the view that - with the whole Basel process, that the complexity of the regulatory response to an increasingly complex and vulnerable and volatile financial system has been part of the problem. That the complexity of the response has allowed again, the most sophisticated global banks to find ways around the rules, even ones that look on the face of it relatively stringent, relatively over-compliant with minimum standards. This has created incentives for banks actually to, in the lingo, arbitrage regulatory standards and in the process the Basel system has actually created a kind of Frankenstein. It's actually provided banks with an incentive, both to avoid rules and also to engage in relatively risk activities. What we actually need is a more simple system.
A simple system such as the one that's being proposed by people advocating simple leverage rations of a more stringent standard.

LYNNE HAULTAIN
So a straight 20 per cent.

ANDREW WALTER

Yes, something like 20 per cent. Of course the banking industry doesn't agree at all and a number of economists, including some of course who have been employed by the financial industry to undertake studies to show that they're wrong disagree.
And the difficulty of the debate is that it's very difficult for voters to follow. So there's a deep question of political legitimacy and accountability here. This was the worst crisis in years. It created mass unemployment, massive costs for taxpayers that we're still dealing with. The response of fiscal austerity that we're dealing with from Australia, relatively…

LYNNE HAULTAIN
Mildly.

ANDREW WALTER
Yes, mildly hit by the crisis compared to deeply hit countries like Ireland and Iceland and so on. The fiscal austerity is happening right across much of the world at the moment. Costs in terms of loss of asset values, pensions and all of these things, low interest rates for savers. The costs are really very, very substantial.
How do average voters understand and judge whether politicians and regulators have responded adequately to the growing risks that the financial sector have increasingly imposed on society at large? The banks say they're doing a wonderful job but have they become so risky, so leveraged that actually when they fail, they are now so big, so complex that the interventions required to stabilise the system are so costly and the unintended consequences of things like quantitative easing we're still living with. Who knows what will happen in the future? Who knows what future crises might be being stored up, by not just the regulatory response but the macroeconomic policy response to this crisis?
So when opponents of increased regulatory stringency say, this is just too costly this will reduce growth, reduce lending, reduce employment and so on, we need to take into account just how costly past financial crises and rising levels of financial instability have become and in particular for average people in society, average voters.

LYNNE HAULTAIN
Andrew there is always at times of great pressure and tension, in this sector particularly, discussion around how incredibly wealthy and well remunerated bankers and traders can be and there is a turn towards them, as if to say, right you guys need to cut your cloth and reduce your income and accept that everybody is suffering some pain. Somehow they always manage not to incur that kind of reduction. Has there been much effort through the last few years at looking at that as an opportunity to claw back some of the money?

ANDREW WALTER
Yes, a lot of resentment in the financial sector about various efforts in this area but equally a lot of continuing anger amongst again average citizens, taxpayers, that not enough is being done. So for example, there is within the so-called Financial Stability Forum, a sister institution of the Basel Committee, a lot of discussion about so-called compensation principles in the financial sector. So don't give bankers and particularly traders - because when we're talking about highly remunerated bankers, primarily and increasingly it's been a relatively small proportion of people in the financial sector but particularly in the most exotic trading activities in the big banks, again primarily in big centres like New York and London. People visible in the media, highly remunerated, very wealthy CEOs taking home $20million or so per year in New York. Sometimes they're traders even making more than that.

LYNNE HAULTAIN
In bonuses.

ANDREW WALTER
In bonuses, yes, and so banks had compensation principles that essentially meant that bonuses were sometimes many multiples of underlying salaries and very short-term oriented. So you could do some wonderful technical trades, get a bonus in January or February, in the millions potentially, and then when the whole thing blew up two or three years down the road, you had already retired on to your island somewhere in the Caribbean.
So a lot of these compensation principles are about the ability to claw back those bonuses, holding them in trust accounts and so on for longer periods of time, even potentially if you leave the firm and so on. There hasn't be a lot of work beyond that at the level of the Basel Committee and Financial Stability Forum because there's a lack of consensus about how much governments should be involved in regulating - here we're essentially talking about regulating the remuneration practices of private sector firms. So the Americans haven't wanted to go along with that, for example. 
In Europe however, where some powerful voices have argued that bankers are over compensated and bonuses have been far too large, there's been an agreement in legislation to cap bonuses at two times underlying salary. Again, we get some responses on the part of the financial sector. Well, if we're to retain our stars and not have them drift off to banks in New York or Switzerland or Singapore or whatever it might be, we will raise the underlying level of salary to ensure that we don't lose our top talent.
So we've had again very different responses in different jurisdictions. And this is the sort of thing that voters, angry voters on the street, can of course understand more easily. Yes, cap those salaries of overpaid bankers who are essentially making money and meanwhile we're underpinning their banks with implicit or explicit guarantees and bailouts during the crisis. Essentially public funds bailing out bankers who continue to pay themselves enormous amounts of money. 
So there's a lot of residual anger so you can understand why politicians in places like Europe might be responding in this way, but again this is a bit of a sideshow in practice because the really core issues are how leveraged are banks. This is where the fundamental issues of thing like capital requirements, leverage requirements, liquidity requirements, the fundamental core of what needs to be done in response to the crisis, this is where it's very tough to sell the message effectively to voters. Yes, we have done good things in this area and we are confident that we won't get a repeat of 2008.

LYNNE HAULTAIN
Well I think there's another whole conversation in how we raise the levels of understanding to a point where, as you say, we can make a reasonable decision and judgement on these matters but we'll have to save that for another time. Thank you very much indeed for joining us.

ANDREW WALTER
You're very welcome.

LYNNE HAULTAIN

Andrew Walter is a political economist and Professor of International Relations in the school of Social and Political Sciences at the University of Melbourne, and a senior fellow at the Melbourne School of Government. You'll find more details of his publications on the Up Close website along with a full transcript of this and all our other programs.
Up Close is a production of the University of Melbourne, Australia, created by Eric van Bemmel and Kelvin Param. This episode was recorded on 30 April 2014 and produced by Kelvin Param and Eric van Bemmel. Audio engineering by Gavin Nebauer. I'm Lynne Haultain, thanks for listening. I hope you can join us again soon. 

VOICEOVER
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Copyright 2014, the University of Melbourne.


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