Summer in the City: Banking Failures of 1974 and the Development of International Banking Supervision

Abstract

Since the global financial crisis of 2008, there have been a multitude of efforts to enhance prudential supervision and regulation of the international financial system. This has progressed across a confusion of national, international and supranational authorities, many of which date back to the 1970s, such as the Basel Committee on Banking Supervision. This article draws on the archives of banks and regulators in order to explore how the architecture of international banking supervision was developed in response to a series of banking scandals in the summer of 1974. This new evidence shows the reluctance which the British authorities displayed in coming to terms with new risks in the global banking system, and the influence this approach had on the operations of the Basel Committee from its origins in 1975. The relationship between regulators and the regulated in financial services has attracted considerable academic attention, partly because banking systems operate differently from other markets.1 The systemic macroeconomic importance of national banking systems makes a strong case for prudential supervision by an outside body, but information asymmetry in financial services and the importance of reputation and private information as key bank assets all complicate the ability to engage in transparent prudential supervision. In particular, the potential for so-called regulatory capture—whereby regulators are heavily influenced by bankers acting in their own interest—is especially strong between central banks and the banking system because of the close connections that are required to supervise complex financial transactions where highly specialised knowledge is needed for the identification and diagnosis of problems.2 In many financial markets the complexity of transactions and speed of innovation has also led to the development of forms of self-regulation through industry standards or professional codes.3 A further incentive for self-regulation lies in the vulnerability of otherwise sound banks to rogue business conducted by a small number of institutions; therefore it is in the interests of well-managed banks to ensure that others operate to the same high standards. In this way, systemic vulnerability increases incentives for market leaders to impose discipline. Finally, trust is an important component of the structures required to ensure compliance, since the information necessary for prudential supervision often incorporates market-sensitive data, and the private information contained in investment portfolios and strategies is a valuable asset for banks. For all of these reasons, the relationship between banks and supervisors or regulators is complex and prone to failures. These difficulties inherent in prudential supervision are magnified on the international level. Because national banking systems are fundamental to macroeconomic policy, their supervision is a jealously guarded prerogative of national regulators. However, the highly integrated nature of national banking systems and their vulnerability to cross-border contagion in the context of globalised financial markets provides a strong rationale for some form of multilateral oversight. Moreover, because rules incur costs for banks, they need to be coordinated to avoid regulatory competition which would leave the global system vulnerable by eroding the competitiveness of those jurisdictions where banks are subject to effective (but costly) supervision and regulation. Shortcomings in international prudential supervision an important in the which in the international banking markets of the to a of to the and of international international in the of in information the of new financial and of banks with a of structures and bank The by these was by the in the of by the of the in the had been for the in This a of the market that had been the of many to and in the This article how a series of bank in the summer of in international banking supervision. In the the to bank the systemic and the was but the had a on international banking regulation. a to national regulators and the of and to close in national banking supervision. the international of central bankers by the Basel Committee on Banking the of the of the has been as the of the Basel new evidence shows that the Committee was to a to the of the and to the of other banking The of this article the and for the of 1974. The explore important of banking the of the rogue and the of the of these case international and regulatory which the of the of the banking system in the 1970s, and which the of the international financial system. The important systemic of the was the of the system the in the importance of for the of the international system had the that from to the of their in terms of the with In the of in the summer of the of the and was in a of was the of The new was in and from on in the of the the and of the also the of had to an and global financial markets a new of by with of such a system. A for was the of and in in which was to competition in the British banking system and a and on bank The was a in and the of a as In the the was to from from to between and a with the of the crisis in and in the by the was back to The in the in the of the so-called in the of in from to and to in These banks vulnerable through the on of the that had but banks the of the crisis through the by the of that the would the market with the banks a coordinated response from the banks, led by the of The of other banks in a banking crisis in a of to a is as a as there was contagion to the market and the the and of a on the banks. the crisis the of a with considerable that its the of to the international banking system. Moreover, the crisis had the that the of for its of to banks. The banking crisis in in that the system was vulnerable to highly and but the international banking the the market in had for a of financial which a number of new the The of banking from the in response to the for services by financial and innovation and the between the regulatory in international banking banks the in international banks had with and the assets of these had from to of the assets of In to the of banks financial in new such as and the attracted to a the of for the to on as in the that with and or trust engage in In this reputation was to the prudential of These the of new banking of In a of financial in in the British of which to have or of the of these was the in with to the in and the of the of these have a reputation for the of in the banks in the and financial The of the summer of a banking crisis as for by and bank such as those which the the the to those which asset markets and and markets In all of the there banks by on the they subject to a of international and and they all to some the of or Moreover, all as for the of the Basel Committee on Banking in and its These the vulnerability of supervisors to through and the of for of such The in was the of the with of assets of The bank was by of the had and was the banks in in the summer of a the but the or of therefore the to the national The of for the authorities of the in which of the was but the supervisors that was in The authorities further such in the of and in also attracted the of the of in the of to and in the to the authorities was that there was a of this was they had important had with the which the in had in the their leave with evidence was for the In of to a close of the and they a of the of was the of that the of had its on a to to and to in for an This was the of the a further that all was in was the was in the of the bank had in and had of the of and a number of the in the case of in and to a of and terms for their In and of the bank of a was in and to and a in but and was a for of trust in from the in to but of which the In with other banks, was heavily in the market and it had as the from the of with the in and the banks and to the but the banks that the had been and would to as a for for such a Moreover, on a of that transparent In the of and the in the international financial markets by the bank the market was the the was their and was in with the was that the bank be they to close it close of business in The bank was or on in but to in the banks of This to the to the of transactions across further led to the of the and the of for In the from banks in a in market and a in international banking as banks the their was a small the systemic of its because of the it to trust in This in trust from the in by and also from the which the interests of international between bankers and and regulators. In the of the bank the of the of the new of the to the from the markets that their and to that in the banking system be in such a as to international in and banks with the that they had to in order to the market banks in in in to a for in an to to the This crisis therefore between jurisdictions and central banks the market to the on trust small banks of business and the of to for to the of that they be because of the difficulties they in the The of to through the and this was to other banks which for of the from or its The of the of supervision the of to markets by evidence to the banking that of are business and their supervision as an important for the a to enhance the of and for a of market that on would be the or and to ensure that for there was from other would ensure that in the Committee to This the of market between the of and the and the relationship between trust and The of had had close with the banks in and their supervision on they bankers to in the and a in the supervision of has that supervision was a of the of and that the Committee of that there other banks and of with the and through its with the However, has that in the the and and that this knowledge trust bankers and also between the of and the The of the of in that to to of British banks in in has the of of banks on from the in the and and the of the as a to the its interests where they have with the In the new from the of markets with many new this was but it some for to be of trust also international between banks. A was banks in a on they the to to banks to on the The of in had a the banks they by but this the to a with the that it had to be on The number of was or on of small but the Committee of that the new led to in and bankers also but was the international the was In the new that international conducted through the the business the date on which the order was The on 1974. the was that the banking system had in complex that vulnerability and that this was by the innovation of which with an that all banks by the and the for was that had the but it to since it was by its the in their and through the in as as the to their was the of the of between of a of to the of be in the of to the some the of this with had been in for some market was to of in to by and 1974. of in to by and 1974. bank was in which was with of to on of as that was they of the in but to In on of an to The for private to of their banks to of their and banks This an that banks have had systems in their with a bank to banks, and that private the for on and the The of to the crisis by the of from British banks, the number of with the and a and other as as by a of the bank to the that information which that the of had been or of the The was to a of which would they This on The of also and of from the of banks in that they would as of for their the Basel Committee that this had a considerable in In the of the trust with banks, by to but the or in The important response to the trust with regulation in the had to the the to in order to authorities in the and the of In response in the the otherwise banks which to the to avoid a of in the banking system as a The was a with in between the the and the with the to enhance systemic a bank by a of for otherwise by and it a response to the in This because the it required a but that assets of banks in that would be by the had been in for the in but had also and forms of The also the vulnerability of markets to the of supervisors in other jurisdictions through the global the markets in the of the the central bank a on in which they the of information between central banks on the of banks in the international market where to further the for central banks to be a of in the that are for that and be and The market was and the high and as as the on the global For a small the of had a considerable systemic and attracted the of the international In particular, the is with the of the Basel Committee on Banking the for and influenced its terms of which the of an system to In the of the cross-border of the bank of the summer of the of the central banks their in to a new the was to ensure bank and with an of and and which was also to the need for an The Committee from for supervision and for the of the banking crisis of the of supervision the of the that of the was that was that the Committee engage in to but to international the was that the was that from the Committee and that the of national regulators was the the Committee the markets had and the had from its of in the summer of 1974. to have been by the supervisors in the of national and and the for had The of the the of the Committee in The was to potential and that had cross-border for to be to a of information on by banks, of banks, and the from that an international system of information and of in banking system that have international of and by the authorities to the and to they to their is to how this an since between it the in international supervision by that and of banks to their and had been but this had or the that the bank Moreover, authorities those of and to to on a there that banks from the they for their supervisors with was on the of the for an international to those that in or for a response to the that an international system be on national the Committee be the for an international In other there be new multilateral or supranational to as a for market the Committee of their that they as a to that their in other to potential from the international operations of their national banks. was or was a of the of it that to on to other or to the that be a bank from other of the of the that was for to that information on or on be to the authorities of other of the of that be a to the potential of to the that be of the that be to other in case the difficulties of a but the same would be to be by other Committee there a In in the trust relationship between supervisors and their national banks was it would other jurisdictions to potential but from other was for information that and the Committee had had from the the of an international and on this the therefore required a the other that and of international system would from the of for the of of information by their own national This was the they to the on this there the of information that be in the form of or and it would the of by the national regulatory In the case of the the Committee that the regulators would have been to on their to supervisors in other as to have further the bank and but they that other supervisors have on from their own jurisdictions that was in the Committee the information which would have been would have been to the In some had been but they to have The information was to to the but from banks in be but there would be to information operations from in has been an important in the of it is the for the of market-sensitive information by the banks to the This trust would be it that be with the authorities in other the to be to banking or the of and others to this in the case of banks in their The of and between a bank and its national or as outside the close of the national regulatory system. The be as a form of self-regulation international banks by in on other to their However, there the to on this The that banks would it as a to the authorities it have The it was a to to of these and also of and in and that supervisors from other jurisdictions or In the the Committee to on to their and regulatory in order to a for the of the Committee that would the others on their and new regulatory the British and the that they had to a of the this to In the in the of an on the of or the ability to a to from banking a and for the on The was to the in a by and on own as an by the the Committee to the that there was of the Committee a new international The of national systems was to be there was that would be the of on a through the Committee and that there in supervision of international that market be for but would need to be and on a relationship of trust central that the Committee was these and had and the of the a coordinated system to ensure that international banking be in the was in of supervisors and those with their to the The was further by the of and the of these banking the need to the in the supervision of international banks and of the markets the of information on banks between In a rogue in the of in was for of or to in as a of In of this was to of the in the of and the a the how vulnerable and banks to the of in the the of to some for prudential supervision of of British banks, a that it had The rogue a of A and to by on the to on from a bank in 1974. evidence from and and was of the of to to with the and the by However, the that some was required to avoid a of such scandals in the the of that the by the in that to the and impose some of and to those that impose on banks in the these the the of the by is a in by to a of there is a in the which have to to own and to the of The of with that of the in the In to in its and that from with the for information on its operations and The the and that their to the operations and of a bank where its and since all on the and of the was for the to have and supervision and to from potential and and that the authorities have to these and These in of the The banks that their systems information on and and as a form of In the to to the to the information to the banking authorities in banking the of the authorities a of their of the of banks, in the of A of the which led the of to was for to the of was by from the through the The crisis led to a on the this to of in the banks required to in the market to to or to the in the this the a on the because of of the the to the the that the for the for and the of the The of the to was and by through the market the that the to of banks a potential on the which was a central of the of the of banks with their was to the of the of was the for the for this since the to be to avoid on Moreover, in the of such would have to be to but the was often the case of the where the British had been a bank have the is that their assets are of and the on and has in the to be to a bank in that are a number of the which it is important to in all the such as the for which the have been a close on the of the market and that the banks their and to the by as as the was also from For and had with the of the of to on their ability to the markets in was of British banks where was a of also with in as a of new which to an In the of the in with the a for the these in the market and therefore there was they a The in the of the and systems between the and was the of the in 1974. In this case the was to be the of the Banking The was an but it have the of and in was In the of to a to be to all banks in of in their This a but such as and the the of and in the to the of However, the the potential to the on markets needed to be The was to all of the banks in the and to the of banks in in 1974. the on banks to a of and and an for that in The in was that the to be of the and that for of their and and to these and how they from these This an important in the of the of the that market through from banking be to from to the this to be of the since the of in the in banks such as the of the was the of of for prudential supervision of and of British banks. A banking a in in the regulatory bank was to an international level. of for to

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