On Monday 12th December, the FSA – one of the main banking regulators in the UK – published a detailed report identifying the failings that led to the collapse and subsequent government bail out of the Royal Bank of Scotland using tax payer’s wealth.
The failings were attributed to a host of factors broadly grouped under internal failings at the managerial level, in addition to the failings of global regulation and finally the failure of the FSA itself in its regulatory approach. The findings of the report essentially call for increased regulation and monitoring to be applied at various levels of management and regulation to minimise the risk of a repeat of the failings.
The problem with this approach is that regulation is dealing with the effect alone and not focusing on the cause of systemic exposure to excessive risk and volatility. No genuine attempt was made to understand the underlying causes of the volatility and the inherent limitation of regulation to tame such systemic volatility which cripples market activity itself.
As far as regulation, much of the financial innovation seen in the last few years has been driven by the desire to bypass regulation (whether this is in the form of the ‘cross currency swap’ derivative which allowed Greece to conceal the level of its debt or the complex synthetic CDO’s which allowed a high profile investment banks to defraud investors).
As much of the financial innovation is driven by the desire to bypass regulatory restrictions, regulation is at best an ‘after the event’ solution.
Furthermore history has shown that powerful interest groups are able to overturn and relax regulation. The Gramme Leach Bliley Act of 1999 and the 2000 Commodity Futures Modernisation Act allowed the shadow banking system to move to higher levels of invisible, Over The Counter trading in dangerous instruments such as Credit Default Swaps.
Based on the inadequacy of regulation, we need to focus on the causes of why firms seek to engage in such excessively exploitative methods in the first place.
The reason is twofold. Firstly there is the capitalist materialistic doctrine where seeking material gain above all else is not only promoted but glorified with mostly horrendous effects on society even though a few individuals may become enormously rich.
The other set of causes is the ever expanding supply of credit which fuels asset bubbles in stock and commodity prices, and inbuilt tendency towards recession driven in part by central banks that manipulate interest rates and fuel debt and unsustainable consumption that leads to the inevitable bust phase of the business cycle.
The solution can only come through a branch and root review of the system and this transcends the economic dimension. The Islamic ideology is the only tried and tested formula to harness the entrepreneurial drive in a climate towards sustainable growth, without the systemic flaws we see in the current order. (Ends)
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