It's not just the banks we have to worry about, says Lord Turner

The FSA chairman says regulation must be stricter, more responsive, and cover every part of the financial markets...

by James Taylor
Last Updated: 19 Aug 2013
Is current banking legislation enough to prevent another financial crisis? In a speech at the Cass Business School last night, Lord Adair Turner, chief of the soon-to-be defunct Financial Services Authority, argued emphatically that the answer was no - not until the banks have a much bigger capital cushions, not until other financial institutions are subject to the same oversight, and not until the regulator gets a lot smarter about how it enforces the rules...

Turner took as his starting point the new Basel III rules governing bank liquidity, which stipulate that all banks must hold a certain amount of capital to protect themselves in the event of another lending crisis. But as he pointed out, banks are not the only debt providers – in fact, there’s a range of other ‘systematically important lenders’ (hedge funds, institutions and so on) which lend money to the banks themselves, whose risk-taking needs to be just as accountable.

What's more, he thinks these capital cushions have been set too low. At the moment, the banks are required to maintain a capital buffer of about 7%. But in order to make them really safe, Turner reckons these buffers really need to be as big as 15-20%. That's all well and good - but as Turner accepts, if the banks did have to put more of their money aside as a capital cushion, this may result in them lending less. And for the time being, regulators are steering clear of anything which might be perceived as slowing the economic recovery.

Still, Turner's broader point was that there's no ‘silver bullet’ to prevent another financial crisis - and he argued that regulators shouldn't get too bogged down in focusing on bonuses, because that wouldn't be a cure-all. The reality, he says, is that financial instability isn’t just driven by excessive risk-taking; it’s ‘driven by human myopia and imperfect rationality, as well as by poor incentives’. So there's another consequence of all this: since the sector is likely to ‘mutate’ to find workarounds, regulators will need to do a much better job of evolving their rules to keep up. They can't just expect to set the boundaries and leave everyone to it; regulation has to become a much more dynamic business.

Today the FSA also published details of its new stress tests, which will require banks to plan for a potential fall in GDP of up to 4.3% between 2011 and 2015. So the controls will be tighter, and banks will have to be a lot more cautious in the coming years. That should be good for stability - but will it also have a damaging effect on growth?

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