Regulatory reforms always start out with well-meaning intentions. However, unless new regulations address the root cause of the problem requiring reform, and interests of all parties are aligned, they are not just less than effective. They can have unintended consequences resulting in greater complexities that actually end up increasing risk. Are we beginning to see some such effects with the recent regulatory reform? The following article from last Sunday’s (April 20, 2014) New York Times may be of interest along these lines.

“Banks Cling to Bundles Holding Risk” by Gretchen Morgenson http://www.nytimes.com/2014/04/20/business/banks-cling-to-bundles-holding-risk.html?ref=todayspaper

Improved understanding of extreme risks can mitigate bank-regulator conflicts

By Karamjeet Paul (Published by GARP Friday, March 14, 2014)

The relationship between regulators and financial institutions can be described in many ways, but one would not be to call them allies. While it is not totally antagonistic, it is also not like a partnership.

Regulators have an objective to protect the financial system and minimize taxpayer costs. A very large part of their efforts, other than to prevent fraud, constitutes protecting institutions from extreme tail risk and drawing regulatory boundaries and limits. Tail risk refers to exposure from uncertainty that is so high that — if it materializes — it can turn into catastrophic losses and overwhelm institutions.

Financial institutions view such boundaries and limits as overly restrictive, even though institutions also have a fiduciary objective to protect themselves from extreme tail risk. Despite this common objective of protection, there is an apparent divergence of interests because of how each side goes about achieving this objective. (Click here to read more …)