The BSA's Jeremy Palmer welcomes some profound and insightful observations contained in Sam Woods’ speech – “Credit union meets robot” given on 24 October at the Mansion House.
Sam spoke about the interesting work that PRA has done, using Artificial Intelligence, to interrogate its existing rulebook and analyse and map the various prudential thresholds and potential cliff-edges that might create barriers to growth.
The analysis has also looked at the question of complexity of regulation, in itself a burden to smaller firms. And Sam also announced a welcome review and part-relaxation of the capital regime for credit unions.
While it is important to avoid unnecessary barriers to entry in banking, the BSA has always argued that it is at least as important to avoid unnecessary barriers to the growth and flourishing of existing smaller banks and building societies (as well as newer start-ups). So it is pleasing that PRA explicitly recognises this – in Sam’s words (emphasis added) :
"We’ve done a lot to lower prudential barriers to entry into the banking sector, with the result that we’ve got a lot of new banks. But have we done enough to lower the equivalent barriers to growth, given no little bank has recently become a really big bank?"
...And a little later: "Now remember: these regulatory thresholds are a direct result of decisions to exercise proportionality by exempting smaller firms from bits of regulation. So they are a good thing from a competition point of view.
"They also ensure that the regulation of different-sized firms is commensurate to the risks that they pose to the financial system, and are therefore sensible from a risk perspective as well as a competition one.
"But thresholds do create the “slope” issue: as firms grow, they come up against these thresholds and have to clamber over them. The key question for us is: does the design of these thresholds, and the way they come together across different bits of regulation, present unnecessary barriers to firms looking to climb the mountain? Have we created any unnecessarily perilous cliff-edges?"
And finally this: "Another thing we’ve been looking at afresh is the complexity of our prudential rules. The scale of the global financial crisis resulted in part from the huge complexity of the financial system, and the many gaps in the rules that sought to regulate it. Fixing these gaps required more regulatory constraints and more regulatory discretion – a necessary increase in ‘essential’ regulatory complexity. But when should we start worrying about ‘too much’ complexity?
This is important for at least two reasons: first, excessive complexity may well be counter-productive in terms of our safety and soundness objective; and second, complexity may be anti-competitive if it is harder for small firms to bear the cost of mastering it. Designing a framework to trade off costs and benefits of complexity is an emerging research question."
Full marks so far, in terms of problem identification. This is radical stuff indeed! On complexity, some may be wondering if their P45s are on the way…..
Simpler, not weaker
What’s even better is that PRA has now synthesised from these insights a powerful new mantra : Simpler, not weaker. Sam said :
"...We do want to look harder at the competition aspect. Small firms tell us that complexity is a real challenge and my instinct is that a simpler – simpler, not weaker – regime for small firms could benefit both our safety and soundness and competition objectives.
"A weaker regime for small banks would be a bad idea, particularly given the steps we have taken under our competition objective to encourage new entrants, who are by definition new and not yet tested in a downturn.
"But a simpler regime, perhaps borrowing from the philosophy of recent moves in Switzerland and the US, could make small firms stronger and more competitive at the same time. This is an area where we may have more room to manoeuvre following Brexit."
The 'simplicity premium'
The BSA has been arguing this case for several years, and has identified areas where there could be a useful trade-off between complexity and resilience – dubbed the “simplicity premium”. That is, where smaller and non-complex firms can benefit from a simpler regime, accepting a slightly higher standard of resilience, and find the trade-off beneficial because the cost of complexity is so great.
Earlier this year, the BSA, together with cooperative bank federations from several other EU states, produced a closely-argued position paper on the need for a structurally simpler and proportionate implementation of Basel 4 for smaller banks across Europe. As said in that paper: "Proportionality in prudential banking regulation does not involve lower resilience on key measures, or weaker standards of customer-facing conduct... correctly formulated, it can deliver financial stability without sacrificing diversity, proximity, or competition."
We also highlighted both the latest Swiss and US approaches to their smaller banks.
Later in the speech, Sam also unveiled PRA’s CP 28/19 – a welcome review of the capital regime for credit unions. As the BSA now represents six of the largest credit unions in Great Britain, we will be responding fully to that consultation... and we're cool about robots, too!
But of equal or greater importance to the majority of our building society members is the train of thought set in motion under the mantra “Simpler, not weaker”. We are watching this space and ready to contribute further...