Lessons From The Past Can Clarify Banking Crisis

"The history of regulation is largely one of regulators trying to catch up after a crisis has arisen," says Professor Catherine Schenk, from the World Economy and Finance Research Programme at the University of Glasgow. She emphasises that while, regulatory changes are a familiar response to financial upheavals that does not guarantee their future effectiveness. "The experience of global crises shows that new guidelines tend to be aimed at the problems that caused the last crisis rather than anticipating the next source of weakness."

During the current crisis, many commentators have called for more robust cross-border regulation of a banking system which has become ever more global in recent decades. But Professor Schenk, whose research has included examining attempts at regulating international financial markets in the decades since the Second World War, points to long-standing and continuing obstacles which face drives for greater multilateral regulation of international financial markets. These include:

• The difficulties of tracking international financial flows and complex transactions;
• fears of pushing markets to off-shore centres which would be more poorly regulated than the existing major national ones;
• lack of agreement between nations on the costs and benefits of greater global regulation;
• perceived threats to national sovereignty.

"In the past, attempts at collaborative supervision have most commonly come after a crisis when an international event has threatened national financial systems," says Professor Schenk. "When a crisis recedes, however, so does the impetus for regulatory reform. Meanwhile financial institutions innovate in ways to evade the new rules aimed at controlling their activities and this can cause new dangers."

"One obvious question is, will the sheer dramatic scale of this crisis strengthen the prospects for greater multilateral regulation succeeding this time?" Professor Schenk explains, "A lot will depend on the effects on the stock market and the wider economy. The extent to which far more people are now exposed to the stock market through pensions, ISA savings and in other ways is one of the main differences between what is happening today and the 1929 crash or the 1982 Latin American debt crisis.

"The financial sector is undoubtedly a very difficult and complex one to regulate. The current initiative, known as Basle II took 9 years to develop and has now been over-run by current events. I think much will now come down to how the regulators police the new regulations which will be developed, and to what extent different national regulatory regimes can succeed in creating and implementing common approaches and features."

Findings were discussed at a workshop 'Financial Crises and Regulation: Lessons from the Past', at the University of Glasgow on Friday 24th October. The topic considered was the collapse of the City of Glasgow Bank, one of Britain's largest, 130 years ago this month in October, 1878. Although depositors did not lose their money the collapse led to the bankruptcy of most shareholders who, like those in many other British banks of the time, had unlimited individual liability. This changed after the Glasgow failure with the rapid development of limited liability in British banking. Previous interpretations of the Glasgow bank collapse – at the time and subsequently – have suggested that it brought to light inherent weaknesses in the concept of unlimited shareholder liability. This view was challenged during the workshop by Professor John Turner, of Queen's University, Belfast who, with Dr Graeme Acheson of the University of Ulster, has recently undertaken fresh research. They conclude from an examination of ownership records, trading data and stock prices that institutional arrangements in force at the time were strong enough to prevent unlimited liability from unravelling. But the City of Glasgow Bank collapse did contribute to the adoption of legislation which tipped the balance of costs and benefits in favour of limited liability.