Financial Services

Economic & Regulatory Reforms

After the Financial Crisis: Europe or the Med?

Seven years after the global financial crisis, economies are on sounder footing. But not all the damage has been repaired, and industry insiders say the financial system remains vulnerable to new threats. They fear that the wave of new regulations could have an opposite effect to what was intended – that it could stifle innovation, reduce competitiveness and drive businesses out of Europe.

Pressed to Act

Europe’s momentum for reform was strong after the financial crisis, Malta’s Finance Minister Prof. Edward Scicluna said. “We cannot fail to witness the enormous amount of financial regulation being enacted in our national parliaments,” Scicluna pointed out. All this was aimed at eliminating threats to financial stability, by strengthening bank capital levels and harmonising banking regulation. “Firstly we set up the European Systemic Risk Board, followed by the three EU Authorities, the European Banking Authority (EBA), the European Securities and Markets Authority (ESMA) and the European Insurance and Occupational Pensions Authority (EIOPA). More recent is the Banking Union itself with its Single Supervisory Authority.” At the same time, the asset management industry faced new requirements through the Alternative Investment Fund Manager (AIFM) and European Market Infrastructure Regulation (EMIR) Directives, he said. The banking sector was preparing itself to take the Capital Requirements Directive IV in its stride, while the insurance industry had finally seen some clarity on Solvency II as it has a two-year timeframe within which to embrace the challenge for day-one compliance. Prof. Scicluna asked: “Are we indeed overreacting and legislating every single financial activity on sight? Maybe. But as politicians we were, and still are today, pressed by the electorate to act in the most wide-ranging manner possible.

Lessons to Learn

“There are still fundamental lessons to be learned,” Jim O’Neill, Economist and former Chairman of Goldman Sachs Asset Management, stated. “While we can perhaps celebrate the Banking Union, it is sort of completed in concept, it seems to me in practice, it is, along with many other issues like fiscal policy and fiscal union and even more basic economic issues facing Europe’s governance, far from in a stable position,” Jim O’Neill, is best known for coining the term BRIC to group Brazil, Russia, India and China as countries whose growth will shape the world economy in the coming decades. He said that although the European economy was showing signs of recovery, in particular the southern European countries, some structural issues had been neglected. “This was not a crisis caused by finance. Finance was sitting in the middle of two very basic things going on in the world. The United States was saving nothing and borrowing money from the rest of the world to build houses and to allow people who did not have any income to own houses. And on the other side of the world, we had China that was saving idiotic amounts of money and not really doing anything other than sending it to investors overseas.” While China’s current account surplus was today less than 3 per cent as opposed to 10 per cent some years ago, Mr O’Neill mentioned that Germany’s current account surplus today was 7 per cent. “In my judgement that is a highly unstable state of affairs.” He also pointed to the low inflation target of less than 2 per cent of the European Central Bank. “The only reason they have that is because of the pressure and success of Germany,” Mr O’Neill said. “Germany needs to accept that inflation can go above 2 per cent.” He concluded: “I do not think it is right for policymakers to spend all their efforts on financial regulations, when the financial problems are a consequence of underlying bigger economic issues that cause the crisis.”

Too Much Regulation

While Kenneth Farrugia, Chairman of FinanceMalta, admitted that self-regulation of the industry had failed, he said: “We are now seeing too much regulation in a short period of time. This is having an impact on the practitioners and the operators, who are trying to manage the short-term market dynamics and the implications of these regulations, possibly at the expense of missing out on the longer-term trends that will shape the competitive landscape of Europe going forward.” He asked whether these new regulations would make Europe more competitive. “We are not in isolation. Europe is competing with the US and with Asia. And financial services is a mobile business, so my worry is that this could lead to a drain of intellectual capability because businesses could move from Europe into other regions.” Mr Farrugia also mentioned that some financial services operators had already decided to go out of a particular service offering, and this “crowding out effect” was detrimental to small jurisdictions like Malta that were still building up their infrastructure. The fact that operators were struggling with all this new regulation would also impact innovation.

Facing Change

John C. Grech, Chairman of Fimbank, agreed that the industry “is facing a situation of over-regulation.” He also believed the current problems are neither cyclical nor financial but structural, and the industry needed to go back to basic. “What are banks for? Banks are there to mobilise capital to support growth and to promote development. They are there to make it possible to invest, to make it possible for entrepreneurs to embark on projects. But are we losing focus? Are we getting more obsessed with the way we run things and why we run things, rather than why we should be standing there at all in the first place?” He would like to see more banks facilitating business in the region, where for instance Islamic finance offers opportunities. “We are not adapting to the change that is occurring around us. Change is required in our institutions, in our policies, in our organisations,” Mr Grech emphasised. Thus far, he said, we “are just regulating against the change, which is causing a tremendous problem.”

Striking a Balance

What we need to understand is that the role of the regulator has changed,” Prof. Joe Bannister, Chairman of the Malta Financial Services Authority (MFSA), said. The MFSA now had a strong focus on consumer protection because consumer protection was affecting the whole financial services sector, Prof. Bannister said. He emphasised that the MFSA avoided prescriptive regulation. “We are not over-regulating. We do a lot of risk-based supervision. We know the proportionality between small companies and large companies. We have direct contact with licence holders, which some other regulators have lost.” He also said that the MFSA did not see businesses moving out of Malta and pointed to the island’s attractive business environment for companies, including its cost structure and infrastructure. Companies could also venture into new areas. “We are a product driven jurisdiction, and by product I mean a regulatory product that we innovate through regulation.” This included developments in the areas of funds, insurance, trusts, pensions and financial institutions.