Why History Keeps Rhyming: The Return of Light-Touch Regulation

The collapse of Synapse, a bank-fintech financial institution in the digital-first ecosystem, was a stark reminder of what light-touch regulation can lead to. Almost everything that could have gone wrong did go wrong, and it all unfolded across the regulatory radar. The echoes of past mistakes that facilitated the 2008-09 Global Financial Crisis were hard to ignore. 

Despite more than a decade of post-crisis regulatory reforms, a year of introspection, discussion, reconciliation, rulemaking, and lawsuits yielded no real solution to the Synapse debacle. Some even call it the “close-to-worst-case scenario” for how a novel bank-fintech venture can unravel. 

Just as the need for a review of regulatory intensity was becoming evident, UK Chancellor Rachel Reeves in her Mansion House speech on July 15 in London doubled down in the opposite direction. Reeves heaped pressure on regulators to allow for more risk to stimulate growth. 

“In too many areas, regulation still acts as a boot on the neck of businesses, choking off the enterprise and innovation that is the lifeblood of growth,” she said. 

The clear message: resist the temptation toward “excessive caution.” Reeves proposed facilitating “better deals on mortgages” and enhancing economic prosperity through regulatory loosening. Her push was a part of a larger government effort to water down several post-2008 regulations, largely in response to lobbying from City firms. 

Among the proposed changes: lenders would be allowed to offer riskier mortgages exceeding 4.5 times a borrower’s annual income. This aims to support more first-time buyers with modest salaries in getting on the housing ladder. 

The plan includes a permanent mortgage guarantee scheme, under which the government will cover losses when a borrower defaults. The scheme is meant to encourage banks to offer 91-95% loan-to-value mortgages. Risk warnings on investment products may also be revised to ensure that people are “accurately” judging risk levels. 

In addition, banks will be permitted to send “investment opportunities” to customers with idle funds in low-interest accounts, nudging them toward stock market participation. The Treasury has already reined in the powers of the Financial Ombudsman Service, which had drawn the ire of many banks for acting like a “quasi-regulator.”

These developments coincide with disappointing UK growth figures. The economy unexpectedly contracted by 0.1% in May, adding to speculation that Reeves may be forced to raise taxes in the autumn budget—an awkward contradiction to the growth-at-any-cost rhetoric.

Mixed Signals 

While the UK Treasury leans towards regulatory dilution, the UK’s Prudential Regulatory Authority appears more balanced in its approach. 

In his June 18 speech, Innovation and Regulation – Striking the Balance at Risk Live Europe, David Bailey, Executive Director of Prudential Regulation at the Bank of England, laid out a more nuanced view. 

He acknowledged that innovation brings numerous benefits, but emphasised the flip side: Innovation comes with costs and risks—both to individual firms and the system. It often requires significant upfront investment, often with uncertain outcomes, as well as long-term planning. 

Bailey highlighted the importance of staying “alert and responsive” to innovation, and maintaining engagement with the industry via roundtables, supervisory meetings, and other channels. His message was clear: the PRA aims to reduce the regulatory burdens only where it enhances efficiency—not at the cost of financial stability.

Let us revisit the root causes of the 2008-09 Global Financial Crisis.

A significant trigger was the US Federal Reserve’s benign neglect and deregulatory stance, which created fertile ground for systemic vulnerabilities. Among the most damaging decisions:  

• Deregulation of the subprime mortgage market.
• A 2004 Securities and Exchange Commission ruling that allowed investment banks to triple their leverage ratios (the amount of risk to capital).
• A nationwide housing bubble that more than doubled home prices in five years, fueled by rising leverage.
• A dramatic rise in household debt—from 80% of personal income in the early 1990s to 130% by 2006.

By 2008, mortgage debt in the US had reached 90% of GDP. The rise in asset prices was being fueled by relentless increases in leverage and a sharp drop in the personal saving rate. 

Compounding the problem was the lack of supervision in key financial markets:

• (a) loan origination, particularly residential mortgage; (b) securitisation of credit instruments; (c) the unregulated $50 trillion credit default swap market; and (d) the oversight of systemically important institutions.
• Inadequate supervision of credit, securitisation and derivative markets, and the exemption of many systemically significant actors from supervision. 

Former Fed Chairman Alan Greenspan signalled his support for financial engineering in a 1995 speech, encouraging asset-backed securitisation. He reiterated in 2005 that innovations like subprime loans helped democratise credit and create global markets.

By 2007, however, he admitted, "I had no notion of how significant these practices had become until very late. I didn’t really get it until late 2005 and 2006." 

But by then, the damage was already baked in.

Fed officials shifted from denial to blame-shifting. In 2005, Greenspan’s successor Ben Bernanke dismissed the idea of a housing bubble entirely: “It’s a pretty unlikely possibility. We’ve never had a decline in house prices on a nationwide basis.”

Later, as the crisis unfolded, Bernanke insisted: “It certainly wasn’t the Fed’s fault…”. “Economists… have found that only a small portion of the increase in house prices … can be attributed to the stance of US monetary policy,” he asserted.

And when Bear Stearns collapsed, the regulators turned to short-selling bans, implying that speculators—not structural failures—were at fault. 

This was not an American phenomenon alone.

Systemic Warnings 

The Bank of England’s July 2006 Financial Stability Report flagged rising household debt and an uptick in credit card write-offs, which reached 5.1% in the first quarter of 2006. Household debt-to-income surged from 100% in the late 1990s to 150% by mid-2000s. The report also noted that the growing complexity of financial instruments may sometimes outpace the capacity of firms to manage associated risks. 

By April 2007, the bank had identified 16 “large complex financial institutions” that could endanger the financial system. Smaller entities, too, posed threats due to their positions in critical market segments. 

Despite all this, regulatory responses remained tepid. In fact, by 2007, US commercial banks had an astounding notional exposure of $153+ for every dollar of equity capital. This remained unaddressed, despite the 199% LTCM report warning that unchecked leverage could cause firm-level failures to cascade the system. 

Crucially, financial shocks had occurred regularly before the GFC—1987’s stock crash, the Gulf War recession, the Asia crisis, the tech bubble collapse, the 9/11, and the Sarbanes-Oxley-triggered accounting clean-up. Yet regulators mostly chose denial or minimal intervention. 

When the crisis finally hit, regulators seemed unprepared and unwilling to admit policy failure. The default posture was denial: of the problem, then of its magnitude, then of their own role in its creation. 

Regulations for new products should be based on research and remain indifferent to pressures from market players. Such an approach would foster resilience in the macro-financial ecosystem.

Indian Prudence 
India has so far remained anchored to a fundamentally different regulatory philosophy—one rooted in tailoring oversight to domestic conditions.

Indian regulators have largely resisted external pressures and market lobbying. As financial ecosystems grow more complex and interconnected, the lessons from Synapse, the GFC, and other crises remind us that smart regulation is not choosing between growth and safety—but striking a sustainable balance. 

History doesn’t repeat itself, but when regulators forget its lessons, it often rhymes— loudly.