What is it?
The UK’s Financial Services Authority (FSA) this month publishes a report proposing fundamental changes to the way banks are regulated and supervised. The objective is to reduce the probability and severity of future financial crises. Bankers accept that the regulatory screws will tighten, but fear that excessive regulation will curb innovation and revenue generation.
Who dreamed it up?
Lord Turner, the new FSA chairman. He was asked by prime minister Gordon Brown last September to conduct the review and reveals his findings this month.
What are the main provisions?
Lord Turner gave an indication of his thinking in a lecture in January. He said there was a need for three long-term regulatory initiatives:
- New approaches to capital adequacy, entailing more capital held against risky trading strategies and counter-cyclical capital requirements to build up adequate buffers during good economic times, which can be drawn on in bad.
- A new liquidity regime focused not just on individual firms’ liquidity but also on market-wide risk.
- Ensuring that financial activity is regulated according to its economic substance, not its legal form.
He is also reviewing other issues, such as excessive pay and bonuses. Alongside the report, the FSA will publish a comprehensive discussion paper on other changes it has already made to banking regulation, those it has proposed but which it needs to consult on, and those where it has defined its objectives but needs to gain international agreement. The FSA’s initiatives are in addition to the independent review of the management and bonus structure in British banks to be led by Sir David Walker announced by chancellor Alistair Darling last month, and to the Banking Bill currently going through Parliament.
What’s in the small print?
UK hedge fund managers are already regulated by the FSA. But Lord Turner believes it would be a good idea if the largest funds themselves – which are usually registered offshore and unregulated – were regulated and subject to prudential limits on leverage, liquidity, capital and risk management.
What does the industry say?
Industry bodies stress that “better” not “more” regulation is what’s required. Simon Hills of the British Bankers’ Association says the idea of building up substantial capital buffers in good times is a sound idea but “Basel II, when fully implemented using through-the-cycle parameters, should deliver a degree of that”. He adds that “it will also be important to get the tax and accounting treatment of capital buffers right, because we would want them to be allowable against tax”.
“We are supportive of reforms to the liquidity regime worldwide, but are concerned the FSA might be front-running these changes,” warns Mr Hills. “It’s important we have globally co-ordinated liquidity responses from regulators. It may be that the FSA is trying to prod other regulators into action, but if it implements the proposal as it stands, it will make the City of London a less attractive place to do business for branches of overseas banks.”
How much will it cost?
Compliance with a raft of new regulation would be costly – but the banks’ critics argue that this is the price of being bailed out by the state.
What do the regulators say?
“The changes which we need to make to create a sounder system for the future will be profound,” said Lord Turner in his speech. “Their guiding principle should be that they should create a banking system focused on the delivery of the value-added functions of banking, which are so essential to a market economy.”
The law of unintended consequences
If reforms are heavy-handed and not co-ordinated with reforms in other jurisdictions, then business could be driven away from London.
Could we live without it?
No. Even avid free-marketeers accept that tighter regulation is needed.
