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Illustration: Henry Wong
Opinion
The View
by Peter Guy
The View
by Peter Guy

Too big to regulate?

As compliance becomes the new name of the game in the banking world, one option for the likes of HSBC is to dismantle into separate entities

HSBC Holdings chairman Douglas Flint made a striking admission last week - that his institution, one of the world's largest banks, is being strangled by new financial service regulation targets.

An uncertain future is in store, thanks to the spiralling costs of fast-expanding and constantly changing regulatory demands.

Flint's remarks also reveal an unpalatable truth for many investors in HSBC - it is too complicated to be effectively managed in today's highly regulated financial markets. In any other business, private equity managers would be circling and encouraging a voluntary break-up.

"The demands now being placed on the human capital of the firm and on our operational and system capabilities are unprecedented," Flint said in the bank's interim results last week.

"The cumulative workload arising from a regulatory reform programme that is increasingly fragmented, often extra-territorial, still evolving and still adding definition, is hugely consumptive of resources that would otherwise be customer-facing."

HSBC added more than 1,750 regulatory and financial-crime compliance employees last year, up more than 50 per cent since 2012. It employs 256,000 people around the world, down from 300,000 three years ago.

Despite first-half profits of US$12.3 billion, the bank seems to be saying it cannot handle the regulatory changes it faces.

HSBC can be seen as a victim of its unusually influential historical roots and success in Hong Kong. Unlike other major global banks, which originated from and are still headquartered and regulated in their home countries, HSBC has expanded far beyond its small but lucrative Hong Kong base into many countries - and beyond any single jurisdiction's effective regulation.

Through a historical twist of fate, it has been quite possibly the financial industry's most effective regulatory arbitrageur, gaining protection - with limited accountability - from the United States Securities and Exchange Commission, the Federal Reserve, the Bank of England, Britain's Treasury, the Hong Kong Monetary Authority, the People's Bank of China and the European Central Bank, among others.

Other nationally based financial groups are subject to much stricter supervision and oversight by single, national entities.

HSBC is a regulatory chameleon, simultaneously claiming to be a local and international bank in Hong Kong, Britain and the European Union.

The result - at least before the 2008 financial crisis - was an implied bank guarantee in every jurisdiction for each of its subsidiary banks' deposits. That meant one government's taxpayers bearing the cost of catastrophic risk that the group might incur elsewhere. Regulators are now clarifying and preventing this through "ring fencing".

Flint has formally requested from George Osborne, the British Chancellor of the Exchequer, a delay of ring-fencing reforms affecting banks in the country while other regulatory reviews are under way.

HSBC's difficulties in conforming to these new rules are a result of its sprawling operations. While it claims to be the biggest bank in Britain and Europe, half of its earnings come from Asia. The British government only wants to commit taxpayers' funds to saving truly domestic financial institutions.

No bank can manage a compliance regime that eliminates risk

Rather than try to manage its way out of the rules-based wilderness, the easiest option would be for the bank to dismantle itself into several entities, separated by definable regional businesses and risks. Hong Kong and mainland Chinese operations could constitute one of them. Europe could be grouped into another.

HSBC has shown the real problem for international banks is not that they are too big to fail, but that they are too big to regulate and effectively manage.

Public policy may essentially be forcing bank executives around the world to confront a decision that none would ever want to face - how to dismantle the entire bank.

The crusade to uniformly derisk banks and force them to achieve ethical purity is a misleading path to what regulators and politicians think is the true and only heaven.

No bank can invent and manage a compliance regime that eliminates systemic and counterparty risk. Understanding the unintended outcomes of over-zealous government regulation is the more important issue.

Trying to protect the fool and his money from being separated is folly because the fool and his money will always be parted from each other.

No government policy or bank compliance officer can, or should, prevent individuals from taking risks and bearing the personal responsibility for their investment decisions.

Risk taking is the necessary lifeblood of banks, and investors will always seek to take risk.

The central mission of financial institutions is no longer financial service and innovation but internal and regulatory compliance. And that will change banking forever.

This article appeared in the South China Morning Post print edition as: Too big to regulate?
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