Banks must resist calls for quick change to tackle the subprime crisis. But they must also not retreat into their shells. Concerted action and a willingness to continue to take risks is the way forward, says John Varley.
Some of the risks taken by banks have gone wrong. In fact, very wrong. Sometimes when that happens, there is a lurch towards risk aversion. That would be bad for the world. Taking risk is what banks do. The financial services industry serves customers and clients and creates value for shareholders by managing risks, not avoiding them.
Much hope is pinned to the banks reporting season. I would say that a transparent reporting season is necessary but not sufficient. Restitution of some sense of normality depends on several notable market wheels ceasing to be still, and resuming motion.
New requirements
The wheels I have in mind are the interbank market, commercial paper and large sections of the asset-backed securities market. Why is this so important? Because now the mechanism of conventional lending and borrowing is inadequate to finance the needs of a growing world.
Continued global growth (with all that goes with it in terms of employment and wealth generation and the social good that comes from that) is dependent on having deep and liquid capital markets that can satisfy the financing and risk management needs of issuers around the world (whether they are governments or companies).
There are some things that would help here. The monoline black cloud needs to get dispersed. If that requires a structural solution then so be it. The subject exerts enormous influence on market sentiment.
Second, we need a continuing message from central banks around the world that they will do what it takes to support economic growth. That will not be easy. It may necessitate taking some risks with inflation. But the message has to be unambiguous.
Third, central banks need to continue to supply liquidity, and they can help the restarting of the residential mortgage-backed security and commercial mortgage-backed securities markets by being prepared to accept this paper as collateral.
Fourth, it would have a significantly (and disproportionately) positive impact if the central banks were to buy commercial paper. Fifth, (and this may take longer) we need to re-establish the credibility of the debt rating system.
Role of the banks
None of this is to say that the restitution of normality is solely the obligation of those responsible for monetary policy. The banks themselves have an important role to play.
In particular, we must not retreat into our shells, as that will certainly create economic slowdown – look at what happened to Japan during the 1990s when its banks stopped lending.
Often in the aftermath of a crisis you hear a clarion call for quick change. So we are hearing, once again, the call for a European super regulator. Not a good idea. The lesson of recent history is that regulation needs to be forensic and specialised. The correct policy is concerted action – just as we saw before Christmas.
Regulatory input
There is a soft role that regulators and government can play, and often play very well indeed. It sounds pretty prosaic. But what it involves is bringing together the market participants?
I am a firm believer in the willingness and ability of the participants, working with their supervisors and their governments, to find solutions to the issues that have been dogging markets for the past months. Arranging a meeting may not seem like the stuff of high policy, but in fact, this approach can often work more effectively than formal regulatory intervention. Risk taking and financial innovation by banks around the world, operating under an appropriate supervisory regime, has underpinned the extraordinary surge in global growth over the course of the past 20 years. It can do it again.
John Varley is group chief executive at Barclays Bank.
