The Politics of Financial Regulatory Reform in Britain and Germany

Abstract

Over the past decade, Britain and Germany have both made fundamental changes to their financial regulatory regimes with the creation of single powerful regulators. In both cases, this meant either ending or severely limiting the regulatory role of central banks. This article argues that the creation of these new regulatory actors cannot be understood without reference to the preferences of domestic political actors responding to the increased political salience of financial regulation as a policy issue. The result was distinct partisan differences about institutional design and responsibilities with centre-left parties seeking regulatory actors clearly accountable to government and parliament. Such an account of institutional change is in contrast to previous accounts of the evolution of financial regulation that are largely exogenous to domestic politics.

Acknowledgements

Earlier versions of this paper were presented at the Centre of Risk and Regulation at the London School of Economics and at the Council for European Studies conference in Chicago. I would like to thank Prof. Susanne Lütz, Prof. Richard Deeg, Dr Thomas Plümper, Dr Raj Chari, Prof. Sofia Perez, Prof. Cathie Martin, Prof. Vivian Schmidt and the anonymous referees of this journal for their comments. All the usual disclaimers apply.

Notes

1. The Economist (1997) commented on the decision to create the FSA: ‘Gordon Brown has astonished the City of London again with a dramatic new plan for financial regulation’.

2. The IMF has pointed out that there has been a marked shift in the bearing of financial risk from the state, firm, and financial institutions to the household sector over the past decade (IMF 2005). The result, with regard to pensions, is that households have had to take on ‘more responsibility for ensuring sufficient contributions to their defined plans, for generating adequate investment return from those plans and for coping with the longevity risk’. They also point to the ‘growing use of mutual funds and direct holdings of stocks and bonds by retail investors have exposed the household sector to market fluctuations’ (IMF 2005: 4). In terms of pension provision, there were also changes in private schemes as an increasing number of firms in the 1990s shifted their pension systems from defined benefit to defined contribution schemes (Pensions Commission 2004: 85). Again, this shift meant that, instead of the firm guaranteeing an employee a pension of a certain percentage of salary, the decision for both the level of pension savings and the type of investment risk was transferred to the individual. For the government and firms, the incentive was reduced costs but, for the individual, the defined contribution pension meant exposure to the volatility of financial markets and the resulting impact on the size of their pension savings.

3. As Muller (2002) points out, significant regulatory tasks such as deposit insurance and auditing were delegated by the BaKred to ‘semi-private’ organisations, confirming that banking regulation had a significant corporatist component.

4. Susanne Lütz argues that the pattern of institutional regulatory reform while triggered by exogenous variables such as Americanisation is influenced by endogenous institutional variables (Lütz 2004).

5. The Gramm-Riley reforms of 1999, which removed the barrier on banks and investment banks carrying out certain functions, meant that any functional argument against combining regulatory reforms is no longer valid.

6. The Lamfalussy proposals were put forward by a Committee of Wise Men in 2001 to suggest a new EU regulatory structure for the securities markets and were subsequently adopted by the European Council and extended to the insurance/pension and banking sectors.

7. The Twin Peaks solution was the model decided upon by the Australian government in 1997 (Financial System Inquiry 1997).

8. The Bank of England was however given the formal responsibility for ensuring the overall stability of the banking system. However, the news was described by two former senior Bank of England officials as ‘a bolt from the blue’ and that it ‘came as a thunderclap’, and it was widely reported that the governor considered resigning (Interviews: London, 17 and 18 May 2004).

9. Credit Lyonnais was bailed out in spectacular fashion by the French government in 1995 and ultimately cost some $24 billion, but this led to no change in the supervisory role of the Commission Bancaire or its overseer, the Banque de France (Coleman 2001).

10. McElwee and Tyrie (2000) devote an entire chapter of their pamphlet to describing the FSA's lack of accountability. They pointed to perceived corporate governance failings such as the initial combination of the role of chairman and chief executive, and described accountability measures to parliament and to ministers as ‘decidedly mixed’ and the chain of accountability as ‘far too long’ and dependent on the willingness of Select Committees to carry out such a task. However, given the regular appearance of senior FSA staff in front of such committees, such concerns appears to have limited credibility. The role of chairman and chief executive are also no longer combined.

11. A former senior Bank of England official described how Bundesbank officials would take pleasure in describing the risks to the credibility of UK monetary policy arising from its financial supervisory role (interview: London, 14 May 2004).

12. An account that confirms this impression was the reported reaction of Bundesbank President Helmut Schlesinger during the aftermath of the Barings failure in early 1995, when questioning his officials about the Bundesbank's potential exposure to such an event, he made it clear that the BaKred's responsibility for regulation should be stressed (interview: Berlin, 15 November 2004).

13. While the Bundesbank gained support from the Länder government of Hesse and Bayern in its opposition to the government's proposals, it had managed to alienate many of the other Länder governments with its proposal to reduce the number of Länder members of its Vorstand (Busch 2004).

14. One leading financial commentator described it ‘as amazing that in Germany it is only the private banking sector that is calling for a legally independent authority in financial supervision. The savings bank sector has been on the sidelines and the cooperative banks openly calling for supervision under the Bundesbank’ (Engelen 2000).

15. In the three previous Financial Market Promotion Acts of 1990, 1994 and 1997, all the parties voted in favor of the legislation and the SPD's main criticism (as the opposition party) was that the legislation was regularly late in implementation. However, as the effect of the first three pieces of legislation was only to bring Germany belatedly into line with the regulatory norms of the other large EU states, and did not involve any contentious decisions about institutional responsibilities, such unanimity was not surprising.

16. As Martin Hering (2005) has noted, the decision to promote pension reform was a major decision for a party that had traditionally opposed it, and was personally promoted by Chancellor Gerhard Schroeder. The fundamental nature of these reforms was the introduction, for the first time, of a defined contribution occupational scheme where employees receive fiscal incentives to participate and where the funds have to be invested in the financial markets. These funded schemes leave the decision to the individual worker to decide where to invest their contributions. While the uptake of the new scheme was initially disappointing, and further changes followed in 2003, the reforms marked a major long-term shift away from state pension provision to one dependent upon financial market returns.

17. Cioffi and Höpner (2004) have argued that a key element in the corporate governance reforms was to improve the transparency of firms' decisions.

18. An example of this commitment was their promotion of the Ministry of the Rights of the Consumer that, among other policy areas, was established to oversee financial claims.

19. Both the SDP and the Greens in the parliamentary debate about BaFin were careful not to criticise the Bundesbank in an overt fashion. As a Green official commented, ‘it is impossible in German politics to criticise the Bundesbank’ (Interview: 15 November 2004).

20. However, despite the opposition party's majority in the Bundesrat, they failed to prevent the legislation being passed into law because of an extraordinary walkout by the CDU leaders in a dispute over immigration policy (FT Deutschland 2002). This meant that the legislation was not sent into the conciliation process that might have delayed the establishment of BaFin for a considerable period.

21. There is the interesting comparison with the decision by New Labour, upon coming to power, to leave in place the significant powers of non-majoritarian agencies in areas such as the regulation of telecoms and energy that were established by the Conservatives following privatisation (see Thatcher and Stone Sweet 2002; Coen and Thatcher 2005).

22. Quintyn et al. (2007) have constructed an accountability index of financial supervisors for 32 states that have undertaken reform and find that Germany and Britain rank as two of the three most accountable of those measured. The index includes 21 separate measures and finds that in the British case, the rating increased from (out of a 100) 48 to 71 and Germany from 62 to 76.

23. US Treasury Secretary Paulsen established a review of American regulation in September 2006.