Labour's deregulation gamble

Nick Kotucha  - Leverhulme Early Career Research Fellow, School of Sociological Studies, Politics & International Relations, University of Sheffield

For a decade and a half, there has been widespread consensus that the primary goal of financial governance should be to prevent the recurrence of a crisis like the Global Financial Crisis of 2008-2009. In the wake of the crisis, the Bank of England was a global leader in the advent of new regulatory safeguards. Over the course of the past year, however, the tide has turned. Labour, historically an advocate for strong regulation, has led calls for less ‘red tape.’ The rationale behind this move is straightforward: less stringent regulations on financial institutions encourage lending and the influx of foreign capital, boosting growth. The risks attached to such an approach, however, are vast — especially so because Labour seems intent on dismantling key elements of the ‘macroprudential’ regime enacted after the financial crisis. 

The post-crisis regulatory agenda

Prior to the global financial crisis of 2008, financial regulators displayed great faith in the self-regulating capacity of markets, reflected in a regulatory regime which focused on the individual conduct of market participants. What was missing from this ‘microprudential’ approach, the crisis revealed, was a ‘macro’ lens which captured broader systemic risks which could materialise even as individual institutions acted in accordance with financial conduct standards. 

In the wake of the crisis, an expansive new ‘macroprudential’ regime designed to regulate the financial system as a whole was inaugurated with astonishing speed. Perhaps the most important component of this regime is its new system for bank capital requirements, which calibrates the capital ‘buffers’ which banks must hold to broad assessments of financial stability. Crucially, macroprudential policy is implemented with aggregate economic welfare in mind. Bank capital requirements, for instance, are adjusted to optimise economic output over different time horizons. That macroprudential policy is already oriented towards balancing risk and growth renders Labour’s attempts at dismantling these policies in the name of competitiveness particularly problematic.

Labour's deregulatory agenda

Some regulations like consumer protection laws primarily aim to protect certain groups or achieve other social goals that are important in their own right, but need not affect financial stability. As I show in a recent article in Political Quarterly, however, the vast majority of the regulations under attack by the Labour government, however, are macroprudential in orientation, thus creating a direct link with economic growth. 

Perhaps the most famous of these regulations is the ringfencing regime, which separates banks’ retail businesses from speculative investment banking activities. Despite warnings by the Bank, Labour has signalled that key aspects of this regime will be hollowed out. Other deregulatory initiatives include relaxations in mortgage rules, including a laxer regime for credit risk assessment. These changes are significant because a deterioration in the quality of credit risk assessments and an increase in risky mortgages were key amplifying mechanisms in 2008. 

Equally worrying are the effects of Labour's competitiveness agenda at the international level. While historically, the UK has played a leadership role in securing international cooperation over regulatory standards, the UK has followed the US in pausing full implementation of the Basel III framework for banking regulation, sowing hesitancy across other large financial centres. While the risks of Labour’s deregulatory agenda are stark, it remains unclear whether deregulation would deliver any positive effects to GDP even in the short run. The Bank of England is adamant that reductions to capital requirements would have negative effects on GDP both in the short and long run due to increased borrowing costs. Even if there are competitive benefits attached to deregulation, scholars suggest that the UK’s financial sector is already oversized and that other sectors ought to be prioritised.

If the benefits from deregulation are uncertain, then why is Labour pursuing this agenda? First, even if the benefits of deregulation are small, there might remain electoral advantages associated with boosting activity in sectors such as real-estate. Second, Labour's goals might be symbolic: Rachel Reeves has repeatedly cast the government's approach to financial regulation as a ‘revolution,’ a narrative which might sway voters concerned with sluggish growth. Third, the City of London was one of the key constituencies that Labour wooed in the 2024 general election; it has a strong incentive to keep City bosses on board by listening to their concerns. Fourth, and relatedly, Labour's closeness to the financial industry might mean that its thinking is being shaped by the narratives of lobby groups. 

Will there be another financial crisis?

The most important test of the new deregulation agenda will be whether it leads to another financial crisis comparable to that of 2008. While unpredictability is part of the very nature of financial crises, recent history suggests that we remain in a world of ever-evolving financial instability. Just two years ago, the collapse of the relatively small-scale Silicon Valley Bank  caused ripple effects across the US financial system and even in Europe, where tight market conditions meant that Credit Suisse required a bailout. In the UK, all it took to create a general panic across financial markets was a badly timed budget announcement by Liz Truss's chancellor, Kwasi Kwarteng. Most recently, problems in US Treasury markets triggered by President Donald Trump's ‘liberation day’ tariffs highlighted yet another source of instability connected to hedge fund activity. 

What these episodes teach us is that we can never predict where the next financial crisis will emerge or what its sources and shape might be. If anything, regulators should continue to explore ways of extending the regulatory perimeter beyond its current boundaries. This is becoming ever more difficult in the current deregulatory climate.

Conclusion

Labour has embarked on a deregulatory approach which might yield some small electoral and economic benefits but comes at the considerable cost of long-term stability. This is especially the case for regulations that are macroprudential in nature, which are the focus of Labour’s attacks. The full folly of deregulation would, of course, only become clear if we were to live through another full-blown financial crisis. Regulators are at a disadvantage in current debates, because the uncertain nature of financial crises means that they cannot ‘prove’ that one will emerge as the result of deregulation. However, the massive costs of the 2008 crisis, and the many examples of financial stress over recent years suggest that it is sensible to adopt a ‘better safe than sorry’ approach.

This article is based on a Digested Read that first appeared in Political Quarterly. The long version of the article can be found here.