Financial Crises and Twin Peaks: Lessons from Australia

by Dr. Andy Schmulow

Philip Aldrick, writing in The Times yesterday, predicted another global financial crisis.

But the UK has learnt the lessons from the last financial crisis, and implemented a new regulatory structure. Hasn’t it?

The Financial Services Authority has been disbanded, and in its place a ‘Twin Peaks’ regime adopted: the first peak, a Financial Conduct Authority charged with market conduct and consumer protection. The second peak, a Prudential Regulation Authority, to watch the banks.

Twin Peaks is now in vogue internationally, credited, as it is, with the resilience Australia displayed during the GFC. Legally, the arguments in favour of a separation of the two regulators are lengthy and compelling. Economically, the evidence suggests strongly that Twin Peaks correlates to more stable banks.

Consequently, it is currently either being contemplated, or adopted, by a range of countries, and is regarded, internationally, as the preferred system.

Long established in the Netherlands, it is under adoption in South Africa, and is up and running in the UK and New Zealand. Elements of Twin Peaks are present in France and Spain, and it has been floated for the USA, China and Hong Kong.

But is Twin Peaks all it’s cracked-up to be? And will it keep the UK safe?

Australia was first to adopt Twin Peaks in 1998, and last year underwent a 14 year review. So it is timely to offer a perspective on its effectiveness, and relay a few lessons from what we have learned in Australia.

While it is true that Australia fared better than most during the GFC, Twin Peaks cannot claim all the credit. Other factors were present, and those should be regarded as equally important for the maintenance of future financial system stability in the UK.

For example, Australia’s banks were not heavily exposed to esoteric products, such as collateralised debt obligations. Their business profile was pretty ‘vanilla’. So that part was not thanks to Twin Peaks, it was simply good luck.

Also good luck was a healthy export trade, particularly in commodities.

Add to that a government that adopted a policy, not of austerity, but of public infrastructure spending, and a cash hand-out to every Australian. In addition, deposits up to a million dollars were guaranteed by the government. That part was also not thanks to Twin Peaks. It was simply good management.

Combine the good luck and the good management with a bank regulator whose culture was more authoritarian, and less given to a ‘light touch’, and this is what saw Australia through.

However, a more determined culture within the bank regulator is not thanks to Twin Peaks. It’s a function of personalities in leadership, the political climate, and the influence that the financial industry is able to exert on government and the regulator.

A strong regulatory culture is therefore vital, and is something you must build yourself. It’s not included in the box.

Further evidence of this has been the poor performance of Australia’s market conduct regulator post GFC.

Market misconduct and consumer abuse are not issues to be underestimated. It was, after all, market misconduct and consumer abuse in the United States’ ‘sub-prime’ home-loan industry that was the cause of the ‘sub-prime disaster’ and which, in turn, metastasized into the GFC.

The Netherlands, the second country to adopt Twin Peaks in 2002, provides further evidence of the limitations of this model.

Three of Holland’s biggest financial institutions had to be bailed-out during the GFC (Amro, ING and Reaal).

So, if Twin Peaks is not the full solution, what is?

The answer is a combination of factors: an activist, willing and capable pair of regulators, adequately resourced and staffed, and indemnified against personal liability, by law.

Legislation which sufficiently empowers the regulators and enshrines their independence. Combined with a culture within those organisations that is independent, and that will seek to enforce the regulations without fear or favour.

And a political system, a regulatory culture, and behind that, a civil society, strong enough to withstand pressure from the banking industry, to compromise on regulations, or on their enforcement.

Combine all of that with a Twin Peaks regime and, it has to be said, foresight and good-luck – for some of this is, and always will be, in the laps of the gods – and you have the best chance possible of avoiding another financial crisis.

Put differently, and to paraphrase Churchill, Twin Peaks is not the beginning of the end of financial system stability. It is merely the end of the beginning.

Adv Dr Andy Schmulow
is an Advocate of the High Court of South Africa, the Principal of Clarity Prudential Regulatory Consulting, Pty Ltd, a Senior Research Associate in the School of Law, University of Melbourne, and a Visiting Researcher in the Oliver Schreiner School of Law, University of the Witwatersrand. He served as a Senior Analyst at APRA, and made extensive recommendations to the National Treasury on the Financial Sector Regulation Bill. He provides advice to the Shadow Treasurer, DA MP Dr Dion George.