Regulatory self capture

Jonathan Ford, Financial Times, 17 March 2019, on  the less observed phenomenon of how regulators can capture themselves through government influence or intellectual fashion.

He cites two examples. Metro Bank, which fulfilled a government need for more competition in the banking sector without costly break-ups for the high-street banks, and equity release which promised a way to address the looming pension shortfall without the state having to pick up the tab.

There was a similarly relaxed view to the rapid growth of ERMs. Firms were allowed to flog these complex products while hugely undervaluing the embedded guarantees contained within them, despite the baleful example of Equitable Life, the world’s oldest insurer, which hit the rocks in 2000 having made the same mistake. Unsurprisingly, ERMs proved highly popular with consumers and the market grew very quickly, ultimately forcing the UK’s Prudential Regulation Authority to re-examine the rules.

The problem with closing the stable door belatedly is that the horse has long bolted. Volumes of ERMs containing mispriced guarantees had already been sold. Capitalising those retrospectively is extremely difficult for the lender, and runs the risk of exposing less strongly-funded providers. Consequently the PRA chose to pull its punches.