WILL A RETURN TO RISK-TAKING ROUSE ANIMAL SPIRITS? / THE FINANCIAL TIMES BIG READ

Will a return to risk-taking rouse animal spirits?

The drive to deregulate in the UK, US and Europe could unleash growth — or sow the seeds of the next crash

Martin Arnold and Sam Fleming in London

UK Chancellor Rachel Reeves’ promise to cut back on red tape comes alongside moves at central banks to reduce burdens on business © FT montage/Getty Images

Britain’s financial services industry has been in decline for more than a decade and the country’s chancellor, Rachel Reeves, has now decided who is to blame: the regulators.

Addressing City of London executives, investors and officials at the annual Mansion House dinner this week, Reeves bluntly declared regulation was “a boot on the neck of businesses, choking off the enterprise and innovation that is the lifeblood of economic growth”.

As the chancellor presented what she called “the most wide-ranging package of reforms to financial services regulation for more than a decade”, she stressed the changes would mean “rolling back regulation that has gone too far in seeking to eliminate risk”.

Britain is not the only country chipping away at the rules introduced to prevent a repeat of the 2008 banking crash. 

Many parts of the world are loosening the regulatory shackles to free up “animal spirits” in financial markets and fuel economic growth. 

At the vanguard is the US, where President Donald Trump’s administration has taken an axe to the regulators and the rules themselves. 

Meanwhile, the Fed, the Bank of England and the ECB are all reviewing capital rules for banks.

Experts say such reforms are part of a familiar boom-and-bust pattern of financial rulemaking: watchdogs are told to take a more lax approach, allowing financial services activity and risk-taking to expand, which ultimately results in a crash and triggers a fresh clampdown.

“What we are seeing now is a recalibration of regulation and movement up the risk curve — throughout history we have seen this,” says Lisa Quest, head of UK and Ireland at consultants Oliver Wyman. 

“But we need to do that carefully with a scalpel rather than chopping back with a chainsaw.”

Still, the global deregulatory drive has been cheered by finance bosses who complain that for too long they have been punished for their role in the 2008 crash. 

In the UK, some are eager for the government to keep up with the aggressive deregulation in Washington. 

“When you put the Mansion House measures in the wider context of what is happening in the US, I see us in a battle for capital investment and keeping companies and financial services in the UK,” says a senior UK banker. 

“This is a very welcome riposte. 

If I were in Brussels and Frankfurt I would be thinking, ‘What is our response going to be?’”

The flurry of measures announced by Reeves this week grabbed the headlines, particularly her plans for an industry-funded national advertising campaign to urge savers to buy more shares — reminiscent of Margaret Thatcher’s 1980s “Tell Sid” campaign to encourage investment in a privatised British Gas. 

The chancellor also promised more substantial changes. 

These include reforming ringfencing rules that UK banks criticise for imposing a costly split of their retail and investment banking arms, and overhauling the Financial Ombudsman Service that bosses say has gone rogue by awarding overly generous redress to consumers. 

Meanwhile, regulators are speeding up approvals, making it easier for listed companies to issue more shares and allowing banks to provide more risky mortgages to people on lower incomes.

This week, the Bank of England announced a delay to certain provisions of post-financial crisis banking reforms, known as Basel III, mirroring a similar move by the EU. 

Both are playing for time to see how the US, which has already watered down its version of the rules, deals with the sensitive issue.

Chancellor Reeves shakes hands with City of London Lord Mayor Alastair King at the Mansion House dinner on Tuesday. Reeves characterised regulation as ‘a boot on the neck of businesses’ at the annual gathering © Charlie Bibby/FT

Other proposals include stripping back the senior managers and certification regime introduced in 2016 to make high-level staff more accountable after the scandals over investment bankers rigging Libor interest rates and foreign exchange trading.

Writing in the Financial Times, Reeves said the requirement for almost 140,000 people to certify they were fit for their roles on an annual basis was “the same flawed judgment that has seen newts and bats block major infrastructure projects”.

Yet some City grandees grumble that the reforms are too incremental, especially given Britain’s declining share of global financial services exports, low share ownership among households and the shrinking number of companies listed on the London Stock Exchange.

“In contrast to the radical tone, the specific measures announced so far don’t seem big potatoes,” says Sir John Vickers, who chaired the UK’s independent commission on banking after the 2008 crisis.

The Treasury says that by cutting red tape it aims to double the growth rate in net financial services exports over the next decade. 

But that comes after the sector failed to keep pace with the rest of the British economy or the global market over the past 15 years. 

The UK claims the highest share of global financial services exports of any G7 country, but it has declined from 21 per cent in 2010 to 15 per cent in 2023. 

The sector shrank 7 per cent after adjusting for inflation in that time, while the rest of the UK economy grew 28 per cent.

The UK reforms look relatively modest compared with what Vickers describes as the “more drastic” changes in the US.

Trump’s White House is threatening to cut funding to the accounting and consumer finance watchdogs, freezing the foreign bribery law, ditching cryptocurrency restrictions and easing bank capital requirements.

The EU, meanwhile, has moved more slowly than either, despite the shake-up recommended in last year’s landmark report by Mario Draghi, the former Italian premier and European Central Bank head.

The bloc has focused on simplifying sustainability reporting rules and continuing efforts to reduce fragmentation in capital markets, rather than aggressive efforts to dial up risk-taking in financial services.

For Reeves, the reforms presented at Mansion House are a key part of the UK taking advantage of having left the EU to move faster than its neighbours in easing regulations.

However, any benefits of being outside the EU seem outweighed by the cost of separating the City from its main market. 

“Most people would say Brexit has acted as a drag on the British financial services sector rather than a lifting of a brake,” says Charles Randell, senior consultant at law firm Slaughter and May who was chair of the Financial Conduct Authority. 

Fears remain that diluting rules could end up planting the seeds of the next major meltdown or scandal in the financial sector.

“We know that when we take a more lax approach to financial rules — bad things happen,” says Nicolas Véron, a senior fellow at the Bruegel think-tank and at the Peterson Institute for International Economics in Washington.

Michael Barr, a governor at the US Federal Reserve, told a Brookings Institution event this week that he was “quite worried” about the deregulatory drive, pointing to his concerns over Fed proposals to reform its stress tests and its supervisory rating system for banks.

“An important lesson we can draw from US financial crises is the role that ill-advised weakening of the bank regulatory framework played in those crises,” he said.

Vickers warns that higher global government debt and borrowing costs make it especially important to keep healthy levels of loss-absorbing capital at banks. 

“In important respects our ability to meet the next crisis is way down on 2008 — and the trade and wider geopolitical risks look much worse,” he says. 

“Because the fiscal situation is so much tighter now, the imperative is even greater to build and maintain resilience.”

Consumer groups are concerned the UK government’s pro-business rhetoric could encourage irresponsible behaviour. 

“Firms are reading the room and thinking what can we get away with here,” says James Daley, head of Fairer Finance. 

“I worry about the most vulnerable consumers in higher risk areas like the credit card market.”

For some in the business community, however, Britain’s efforts to dial up financial risk-taking do not make up for initiatives going in the opposite direction. 

The government is pushing through reforms to give workers more job security and strengthen the role of unions, which risks making labour markets more rigid.

At the same time, companies warn they are being forced to push up prices or shed workers in response to Reeves’ £25bn increase in employer national insurance contributions and a sharp increase in the national living wage. 

Sentiment is being further dented by the growing prospect of tax increases in the Autumn Budget as curtailed growth prospects weigh on tax revenue and welfare U-turns push up borrowing. 

The economy has contracted for two months in a row, according to official figures, while analysts predict Reeves could face a fiscal hole exceeding £20bn in the autumn. 

City workers pass the Bank of England earlier this month. The UK economy has contracted for two months in a row, according to official figures, and businesses are concerned about possible tax increases with the Autumn Budget © Chris Ratcliffe/Bloomberg

Erik Britton, a former Bank of England official who is now at Fathom Consulting, says Reeves is right to push for more risk appetite in the economy, but wants “much more aggressive” pro-growth policies.

Cutting red tape is not enough on its own, he says, calling on the government to consider ditching its less business-friendly policies. “If they mean it about growth then for a while they will have to abandon the other targets or dial them way down.” 

If the chancellor does come back this autumn with fresh tax increases on business, financiers warn that any goodwill from the Mansion House speech could be rapidly dispelled.

Investors are increasingly asking how much people will “get whacked” by tax increases in the Autumn Budget, says Simon French, chief economist at Panmure Liberum, amid speculation about potential wealth taxes and a higher bank levy. 

At present, the Treasury imposes a levy and a surcharge on banks, both created after the 2008-09 global financial crisis. 

Together they are on track to raise more than £2.5bn a year by the end of the parliament, and some Labour backbenchers argue they should be boosted. 

The announcements Reeves made at Mansion House were “incrementally good”, French says. 

But “as much as she is trying to garner animal spirits among banks, investors and consumers, there is this cloud hanging overhead”.