Banking reform at the edge of the precipice – the latest news – Report 3
The emerging debate on post crisis reform of the financial system and bank regulation
In his speech on 14 October, Gordon Brown set out the five principles which he proposes should underpin the international financial system:
- the need for improved transparency;
- integrity - which he linked to pay and bonuses (see above) and the need not to reward short term irresponsibility;
- the competence of board members to manage their business and the risks it faces;
- revised rules on solvency and liquidity; and
- new international arrangements to replace the current institutional structure which goes back to the post war period and Bretton Woods.
International co-operation and structures clearly do need to be improved to match the global nature of markets and systemic risks. It is also vitally important for the UK and the City of London, that the new bank regulations are adopted internationally to avoid business leaving the UK as a result of our domestic regime being more restrictive than competitor centres. This applies in all areas, from capital to remuneration and to any more far reaching restrictions on retail deposit takers.
There are also likely to be questions raised within Europe about the fundamental principle of mutual recognition upon which the single European banking licence is based. The need for the UK to invoke powers to seize the assets of an EEA authorised bank strikes at the very heart of mutual recognition on which EU legislation is based. The Landsbanki collapse has demonstrated that mutual recognition of a bank’s authorisation in another EEA state may involve substantial risks for local depositors, local taxpayers and the local compensation fund; some may now question the wisdom of the principle, particularly in relation to small states such as Iceland, Latvia, Estonia and Malta. It certainly does highlight the importance of ensuring that mutual recognition is based on real harmonisation and co-ordination of regulatory policy and standards, and equivalent supervision and enforcement.
Hector Sants gave a speech on 14 October - ‘How is bank risk to be managed’. This was largely a defence of FSA’s recent performance, and advocacy in favour of FSA’s continuing regulatory role within the tripartite structure reflected in the Banking Bill. It may be read as an early shot in the debate about regulatory reform, particularly against those who are starting to question whether a conduct of business regulator focusing so much on retail sales and customer treatment, is best placed to grapple with international bank liquidity and solvency.
The single regulator model adopted under FSMA and in some other European states, is now being scrutinised. Would a central bank, with its close market dealings with banks in the context of its liquidity and money market roles, be better placed to regulate bank solvency and liquidity and to co-ordinate this with the broader systemic regulation of the financial system; or at least to regulate those banks which are sufficiently large to pose systemic risks? This was the model in the UK before the Labour government reforms and is still the model in various European countries.
Whatever the institutional structure, it is critically important that bank supervisors have the necessary banking expertise and that they have the confidence and authority to deal with the banks they supervise in areas such as liquidity.
