Why Longer Regulations Aren’t Necessarily More Complex 

The instinctive way to judge a financial regulation’s complexity is by its size: the sheer number of pages it takes to spell it out. The Dodd-Frank Act, for example, runs to more than 800 pages, while some banking rulebooks stretch into the thousands.

Since the 2008-09 global financial crisis, financial regulation has expanded dramatically and, in the absence of a better measure, the length of a rulebook is often treated as a proxy for its complexity. But we suggest that page counts can be misleading.

Beyond page count

In our research, we found that two features of a regulation matter far more than its number of words: the number of rules woven into the framework and the breadth of concepts firms must wrap their head around to comply with it.

The implication for policymakers is that a shorter rulebook is not necessarily a simpler one. Cutting pages, while welcome, may not be enough. They may need to focus more on reducing the obligations contained within a rulebook and the concepts nestled within it.

We relied on a survey conducted by the EBA on banks, asking them which banking rules were the costliest to them. We correlated the answers to measures of complexity that we built in our research. In particular, once we accounted for the number of rules and ideas in a regulation, page count largely ceased to matter in our study. When we analysed the costs of regulatory compliance, the number of rules explained almost everything, accounting for 89% of what drove the differences in those costs. The document’s length explained virtually nothing.

As we write in the paper: “These results mean that a policymaker who would try to simplify regulation by targeting length but keeping the content constant… would presumably completely miss its objective.” 

Complexity is also very costly. We point to European Banking Authority estimates suggesting that compliance with supervisory reporting requirements imposes costs of €19.6 billion on European banks, roughly 5% of the sector’s total operating expenses. Banks themselves spotlighted the difficulty of understanding regulatory requirements as the main driver of those hefty charges.

The compliance burden also falls unevenly across the banking sector.

Large and medium-sized banks appeared to be more affected by the sheer number of rules they were required to follow. Smaller lenders, by contrast, were more sensitive to the breadth of concepts they had to get to grips with.

We suggest this may be because smaller lenders are often exempt from many reporting obligations but still face the fixed cost of understanding what the rules actually mean – a burden that may be especially hard for smaller banks with limited resources to absorb.

Measuring the problem

Part of the problem is that regulatory complexity remains surprisingly difficult to define, let alone measure. Nobody can agree on how to best measure it, despite many discussions in the regulatory community since the 2008-09 meltdown.

In our research, we sought to change that and, drawing on ideas from computer science, developed a framework that breaks regulations down into their various parts, which helps us identify which aspects of regulations are most closely connected with complexity. 

Yet we are not arguing that regulation, introduced to make the financial system safer, should simply be stripped back. In fact, we note that some complexity exists for a very good reason: detailed rules can make rules more precise, which lets policymakers match them more closely to the risks they are trying to curb.

The challenge is working out when complexity is adding value and when it is simply adding a burden – one that can translate into billions of euros in compliance costs across the European banking sector.

Our contribution is to provide a framework for making that judgement more logically. And the goal is not less complexity at any cost, but a better understanding of when complexity is worth the cost.