The tale of the letter and the spirit
Every so often, inspiration strikes from the unlikeliest of sources. So it was that Friday night, inspiration struck; via the Big Bang Theory.
Leonard, attempting to behave as a good friend and roommate, was frustrated at every turn by Sheldon’s indomitable ‘room-mate agreement’. But rather than promoting the simple desired outcome of ‘reciprocally considerate cohabitation’, the overly complex contract had encouraged quite the opposite, and argument after argument ensued.
Sheldon’s mistake, unwittingly made, was focusing on exhaustive detail over fundamental principle, promoting compliance with the letter, not the spirit. Thus, my eureka moment; this is the primary mistake we make with financial regulation.
Take FATCA, which, at its heart, is quite simple. It can effectively be summarised as “as a US citizen, you must declare and pay taxes on all your taxable assets held outside the US. As a financial institution offering services to US citizens, you must declare US citizens’ taxable assets to the US government”. That, coupled with a standard template and annual submission date, should really be enough. Instead however, we have a 48 page law, with incredibly complex and technical caveats, citations and exemptions. Regulatory traditionalists argue a simpler approach would promote ‘unclear’, ‘vague’ and ‘un-implementable’ regulation. The problem with this argument is that Banks use ‘clarity’ as a synonym for ‘exhaustive rule book’. Rather than clarify the ask, such rules simply set the parameters outside which anything goes, like the Rebel Alliance examining plans to the Death Star; “impregnable, except for that tiny ventilation shaft you overlooked”.
Capital adequacy is a prime example of the perpetual ‘detail-loophole-revised detail’ cycle which regulatory complexity creates. Rules are continually revised, amended, enhanced and, consequently, regulation becomes increasingly difficult to interpret and implement, thereby undermining its efficacy in the first place. Bank leadership can’t manage it, regulators can’t monitor it, and the goal of a well-capitalised banking system is lost in inconsequential semantic debate.
Entrusting fair interpretation of regulatory intentions to Financial Services firms is touted as an insurmountable obstacle to a simpler approach. FS has hardly been characterised by what anyone would class as ‘better judgement’ of late. But complexity and technicality don’t promote better judgement; they encourage quite the opposite.
Codifying an ask into complex rules fundamentally alters the dynamic of any relationship. It implies mistrust, and promotes either duplicity, or mindless adherence exclusive of sensible application. This, in part, is why terms and conditions on financial products became so complex. Firms complied with regulatory requirements, but to what end? Customers were no better off, nor more informed of the substance of banking products; the only consequence was that banks sated a tick-box regulatory appetite.
Why not aim for the principle and, where disputes arise, engage in open, sensible and transparent discussion to resolve them. Let reasonable interpretation triumph over exhaustive definition and hawkish loophole analysis.
We hear a lot about the reintroduction of moral culpability into banking, but what we say and the behaviours we unintentionally promote are separated by an increasingly vast chasm. Only by moving from complexity to simplicity, can we move from compliance of the letter to compliance of the spirit.
Isn’t that what a better banking system should be all about?