Recent media reports suggest that the Basel Committee has pushed back its meeting to finalise the Basel III regulatory package, citing difficulties reaching agreement on the level that should be set for new capital floors. This issue is the tip of the iceberg of a much bigger debate: the trade-off between simplicity and complexity in the design of regulations. That debate is nowhere near settled.
This blog from the Bank of England considers whether regulatory complexity has been unfairly maligned. The defence comes against the backdrop of increasing weight being placed in post-crisis re-regulation on more simply specified measures. In addition to the important points the article makes, my experience of working with firms is that the complexity of the task of implementation is every bit as important as the complexity of the formulation of the regulations. Even simple rules can have disproportionate (not just unintended) consequences.
As this debate continues, it may be time to shift focus (again) from how to regulate to what to regulate. If genuine progress has been made in reducing risks to insured deposits and financial stability and thereby to the liabilities that governments ultimately underwrite, the most intense regulatory scrutiny could be reserved for the residual, narrower set of activities.
simple rules can achieve complex tasks: by simply adjusting its speed to keep its angle of gaze fixed, a dog can manage the complex task of catching a Frisbee. In this post, however, we argue that some financial risks are hard to catch with simple rules – they are more like a boomerang’s flight path than that of a Frisbee. Complex rules can sometimes do a better job at catching risk; and simple rules can be less prudent