The real impact of financial regulation

In the wake of the 2008 global financial crisis, banks and insurance companies have been subject to increasing regulation and control, the aim of these regulatory reforms being to ensure a crisis like this could never happen again. “Very little research has been done on the actual impact of that regulation on the financial sector, its clients and the economy as a whole,” says John Hollows, Chief Risk Officer of the KBC Group. Research undertaken within the scope of the new KBC Chair aims to do just that – because a lot is at stake. What are the issues and concerns involved and why do they merit investigation?

John Hollows (KBC) and Filip Abraham (Vlerick)
John Hollows and Filip Abraham

Many people, even within the financial industry, find it difficult to understand the complexity of financial regulation and to keep up with what’s happening, as John explains: “The sheer volume of new regulations is quite unprecedented. In the last six months, the European Banking Authority (EBA), for example, has issued about 30 technical standards. And if people are struggling to understand what’s coming their way, then they will certainly struggle to understand what the impact may be.

It’s about Europe’s future

One of the questions is, if the capital and liquidity requirements increase, will it be possible for banks to continue to lend as much money as they did before? Across Europe, banks’ risk-weighted assets are already significantly lower than they were five years ago, i.e. they’re lending less than they used to. And whereas companies in North America typically turn to venture capital for additional funding, European companies have been heavily dependent on bank loans. Consequently, if banks aren’t in a position to lend to companies to enable them to invest, grow and employ more people, then where does that leave Europe in terms of recovering from this period of stagnation? These issues aren’t limited to our organisation or our sector; these are concerns for society as a whole. They touch upon the way the European economy is structured and the future potential of Europe to grow and to deal with the challenges ahead, such as providing for an ageing population, migration, etc.

Remain attractive for investors

And there’s another reason why John believes this is a legitimate area of research, not just for bankers but also for macro policy-makers: “The very fact that there’s still a great deal of uncertainty about regulation going forward means that the financial industry becomes less attractive for investors. So while commentators agree that banks need more capital, if the regulations are such that investing in banks becomes rather unattractive in terms of return and quite uncertain, because more regulatory requirements may be imposed, then the necessary private capital to support the financial industry and the real economy may not be forthcoming.

Bonuses under scrutiny

The feedback we get from players in the financial sector is indeed that they worry about the accumulation of regulation at different levels and the interpretation of this regulation. So it’s no surprise that they wonder whether in these circumstances they’ll be able to maintain the return on investment required to attract capital to the industry to fulfil their socio-economic role,” explains Professor Filip Abraham. He’ll be closely involved in the research, together with his Vlerick colleague and financial regulations expert, Professor Freddy Van den Spiegel, and researchers from Vlerick and KU Leuven.

A lot is happening simultaneously in different areas,” adds Filip. “The increased capital and liquidity standards have already been mentioned, but bonuses, for example, are under scrutiny as well. There’s Basle III, Solvency II, various regulations issued by the EBA and the banking union and, to add to the complexity, there are all the national regulations to be reckoned with, and those are not always consistent.

Synergies become impossible

Obviously this has consequences: “Financial organisations, like KBC, are operating in several countries. With financial regulations differing between countries, it may become very difficult to set a common strategy and to streamline operations. Consequently, the intended synergies may no longer be achieved. The new regulations have forced banks that used to lend across different markets in Europe to withdraw to their local markets. A Spanish company, for example, used to be able to borrow from a German or Belgian bank, but this has become well-nigh impossible. In countries with high savings deposits, such as Belgium, it’s increasingly difficult for banks to find profitable allocations for these deposits.

Balkanisation of banking

John agrees, adding: “Over the past few years European countries have become financial fortresses. This ‘Balkanisation’ of banking is in stark contrast to the European dream of the free flow of resources.” John can’t stress enough that the stakes are way beyond the health of the financial system. “If you believe that banking is crucial for European prosperity, then you should thoroughly analyse the consequences of the new regulation.

Holistic view

Research so far has focused on describing the existing and proposed regulation and at best has pointed out some macroeconomic consequences. Filip explains this new research will be different: “What we will do is actually make the translation into practice. How does this regulation affect the business models, strategies and operations of financial institutions?” The team will analyse huge amounts of available financial information on European banks and insurance companies. The results of the analysis, research and policy papers will be discussed in workshops and round tables with a wide range of stakeholders – individuals, companies, financial services providers, supervisors and policy-makers – to obtain a holistic view on the matter. “We’re looking forward to these discussions, as they will also help us gain a better understanding of the topical issues in the financial sector.”

It’s a view that John shares: “We hope this research will not only benefit ourselves, but also educate a much wider constituency that is interested in banking and insurance and in seeing a healthy financial system in Belgium and also in Europe.”