So the banks colluded… where were the regulators?
By now most people would have heard about the Competition Commission’s referral to the Competition Tribunal regarding the alleged currency manipulation by 17 banks. In particular, the Commission is accusing the named banks of colluding over the bid and offer prices for the USD/ZAR currency pair.
The Commission claims that this collusion goes at least as far back as 2007. However, according to the Commission’s spokesperson, it is difficult to determine the extent to which the price of the rand has been affected.
As could be expected, political parties and the public are calling for the banks’ heads on the chopping block; after all, few business sectors are as hated and demonized as banking.
The African National Congress (ANC) says the findings by the commission have raised doubts about the capabilities, trust and independence of the country’s banks.
The Economic Freedom Fighters (EFF) says it will be writing to the South African Reserve Bank to immediately discontinue banking and operating licenses of the banks named.
The ANC says corruption in the private sector has been rampant for too long and says now is the time to diversify the financial sector, introduce new players and transform the industry.
Yet the one question nobody seems to be asking is: where were the regulators during all of this?
Why do we need financial regulation?
As its name suggests, one of the defining features of the financial services industry is that its products and services revolve entirely around money itself. Because of this, many argue for stringent regulation of the financial sector.
Some of the reasons offered for such regulation include improving market efficiency, reducing financial crime, maintaining confidence in the financial system, and protecting consumers and the public. Most importantly, the ‘need’ for regulation is almost always justified by claiming that regulation it is meant to be preventative.
But how effective is government regulation at fulfilling these goals? All things considered – including the magnitude of the ‘scandals’ that have managed to slip past regulation – it appears to be quite inept. Consider some of the events in recent years: sub-prime lending and false credit ratings in the US, the uncovering of banks ‘rigging’ LIBOR rates in the international markets, and now the alleged collusion around foreign exchange in South Africa.
Regulation should prevent precisely these sorts of events from occurring, but when such events do occur, punitive action is used as a substitute. Issuing fines and penalties post hoc is like drawing a chalk outline around a corpse – it doesn’t prevent what has already transpired.
Furthermore, the Commission’s statement indicates that the banks have been engaged in collusive activity for around a decade now. Insofar as such activity has been harmful, regulation has seemingly done nothing to prevent such harm in that duration.
Big picture: it’s the State’s mess
Here we get to the heart of the matter. The point of this article is not to claim that more or different regulation is needed – indeed, no matter how many laws or regulations are written, it seems that regulators may still miss major ‘problems’ in the market.
Firstly, in a free market, anybody would be able to trade currency pairs. However, as in most countries, a small group of companies has the legal privilege of dealing in foreign exchange. This has the effect of restricting the ability of others to enter the market and undermine their competitors’ collusion; in addition, with fewer permitted players in the currency markets, the logistics around coordinating currency manipulation become much simpler.
Secondly, some people have claimed that all South Africans have been affected by the alleged currency manipulation through its effect on the petrol price, as an example. But this can only be a problem if we have no option other than to trade in the manipulated currency. Taking a step back, it becomes clear that the underlying problem is not that currency could be relatively easily manipulated, but that we are compelled by law to use a certain currency.
Lastly, even with perfect regulation of the banking sector, we could never expect currency manipulation to go away. As one of my colleagues rightly points out, central banks exist to ‘manipulate’ the value of their currencies. The Reserve Bank does this on a daily basis through its transactions with other banks, and through the creation of new base money.
The price inflation that all South Africans experience, and which lowers the purchasing power of the rand, is not merely an unfortunate by-product of such activity – it’s a deliberate goal. Remember: the Reserve Bank targets annual consumer price inflation of 3-6%. One is therefore left wondering whether currency manipulation is bad per se, or whether it is only a problem when anyone other than the arms of the State engage in it.
Are the banks to blame?
Many South Africans are angry at the banks named in the Competition Commission’s statement. But for the most part, banks are merely operating in the environment that the State has carefully (or carelessly, depending on your perspective) crafted for them.
Fiat currency, fractional reserves, reduced competition, moral hazard, and implicit bailout guarantees are all products of rules set out by the State, and not the banks themselves. As such, the ongoing string of banking ‘scandals’ is likely far from over.