It was August 2007 when the edifice of the financial services model began to crumble. The term sub-prime loans entered the lexicon, swiftly followed by special purpose vehicles, collateralised debt obligations and the Libor rate. Today’s white paper, unveiled by Alistair Darling ensures we will not go back to the days of light-touch regulation, however much the bankers might like to return to business as usual.
Darling does not attempt to destroy the status of the City of London as the global capital of banking, and that is appropriate. The City is one of our largest creators of jobs, tax revenues and wealth. But, the white paper does change the rules of the game in important ways. In particular, the FSA will have greater powers to tackle excessive risk taking by banks – including making them put aside more capital and by publishing an annual report on whether banks meet a new code of conduct on remuneration. The white paper also supports tougher rules and greater transparency for hedge funds, greater consumer protection and education and better co-ordination between the Bank of England, Treasury and FSA.
What the white paper did not do was chuck out all the 1997 reforms to banking regulation and start again. George Osborne has said he would give the Bank of England responsibility for day-to-day regulation of the banks and building societies. But, he doesn’t say what tools he would give the Bank to do this. Osborne hopes that focussing on structures will obscure the fact that he has little to say on the specifics of regulation and reform. In terms of the substance, the Tories are once again found wanting.
On structures then, the Tories say all powers should sit with one institution (the Bank of England), but the reality is that big policy challenges cannot be fixed in one building, even one as grand as the Old Lady of Threadneedle Street. Whether it’s climate change, global security, child poverty or financial services no one department or country is going to have all the knowledge, expertise or powers to effect change. Darling’s creation of the new Council for Financial Stability will ensure greater collaboration between the key players – the Bank of England, Treasury and FSA. The fact that the chancellor will chair these meetings with minutes published quarterly adds weight to it. But it is wrong, and counter-productive, to pitch the Bank, Treasury and FSA against each other, as Osborne is trying to do. Success requires joint working, drawing on the skills and expertise of the different departments, but directed towards a common goal. Today’s white paper does that.
That said, outstanding issues on the substance remain, and the white paper will not be the last word on reform. For example, as well as putting aside more capital and greater transparency on pay and bonuses, is there more that can be done to encourage banks to behave responsibly? For example, through liquidity rules, mortgage lending ratios or shareholder power to over-turn board decisions – including on remuneration.
In addition, although the white paper says that it is not the structures or complexity of a bank that determines whether it fails or not, it is clear that opaque products and complex operating models made it harder for boards and regulators to do their jobs. It also made bailing-out the failed banks harder, while necessitating action given the risks of contagion. The size and complexity of banks do matter, and more thought needs to be given to what the banking sector might look like in five or ten years time.
Darling also announced that he wants to sell off the nationalised banks to repay debt. That is laudable, not least given our fiscal position and pressure on spending. But, given our ownership of such a chunk of the financial services sector, let’s think imaginatively and creatively about what legacy we build. There are exciting ideas to re-mutualise Northern Rock for example, and even if you don’t want to break up the super-banks – Lloyds and RBS – we should at least give more attention to the idea floated by Adair Turner that the banks cannot use secure retail deposits to speculate in highly risky ‘assets’ that have added to the instability of the system.
But, the 176 page detail in the white paper takes us forward considerably, and once implemented will make our financial services sector and wider economy more secure and stable.
The white paper takes forward commitments made at April’s G20 summit in London to reform financial services globally. But to make the maximum impact, reform must be at a global level. In September the G20 finance ministers meet in London, soon after world leaders convene in Pittsburgh. The UK is in a strong position to lead discussions on a global framework for financial regulation. Nobel prize-winning economist, Paul Krugman, famously declared last autumn that Gordon Brown had saved the world’s financial system (or even the world!). But rescuing the financial system and with it the real economy was just the first step. Today’s set of measures will help build in the wake of the crisis the more robust, fairer and transparent capitalism we need.