Jim Armitage: Don’t just blame robots, regulators had part in pound’s lurch

Regulating banks is like bouncing on a waterbed. Jump on one side and the other sloshes up.

The world’s financial watchdogs thought they were making the world safer by pouncing on the amount of risk major banks can take with their own money.

They were. In general, the deleveraging of banks was the right idea; too-big-to-fail lenders have massively scaled back the trading gambles they make with their money, meaning there’s far less chance they’ll need bailing out by the taxpayer again when their bets go sour.

But up pop a whole load of unintended consequences. First off, as Donald Trump keeps reminding us, stringent capital requirements on US banks are crimping lending to healthy homes and businesses. For once, he’s probably right.

Now, the report into October’s sterling flash crash tells of another by-product: restrictions on bank risk-taking are a key cause of the trading spasms that keep hitting the markets.

Here’s why: harsher capital requirements mean it’s far less lucrative now for the major global banks to act as market-makers, buying assets and holding them until they find a buyer at the right price.

Understandably, they’ve gone elsewhere to seek more verdant pastures. So, when you get a sudden surge in demand from investors to buy or sell at a time when most folks are asleep, or off on holidays, nobody’s got enough of the stuff available to fulfil the order at a reasonable price. Result? Prices lurch dramatically.

Meanwhile, the exit of big market-makers means legions of experienced traders at the major banks around the world who would have known what to do in a fast-falling market have been laid off.

October’s flash crash started as a wobble in sterling during the wee hours when trading had moved from the big London and New York markets to understaffed desks in Asia. The young shavers in charge out there inevitably lacked the expertise or authority to do the right thing and make a reasonable price. Some in London even worried that doing the right thing might be against the rules.

The Bank for International Settlements report said it was now coming up with another set of standards for currency markets. As one FX veteran huffs: more regulations. Just what we need.

The headlines around today’s report will doubtless all be around how algorithm-driven robot traders caused the crash.

It’s true, automated trading programs were guilty of triggering orders that added massive pressure on the pound.

But it was the humans operating them who turned a ripple in the waterbed into a tidal wave.