More regulation?

We can be sure of one thing. On both sides of the Atlantic the architects of the current failed system of regulation will conclude we need more regulation in the future. They will be interested in what they can add to an edifice which worked badly, not thinking about what they should demolish before rebuilding.

In the UK we should expect two things. They will wish to strengthen the Tripartite system rather than replace it. Instead of transferring FSA powers over banks to the Bank of England, and giving the Bank a unified command over bank supervision and the money markets they use, both the Bank and the FSA will be given bigger roles in regulating banks.

There is unlikely to be a Glass Steagall law requiring the separation of investment banking from clearing bank activities. The authorities rightly understand that some of the weakest banks in the last crisis were either traditional mortgage banks like Northern Rock, or specialist investment banks like Lehmans. The large conglomerate banks got sucked in to the crisis at a later stage.

Instead they think they will increase the capital and cash requirements of both investment banking and traditional banking activities, probably being tougher on the former. This will limit the capacity of any large bank to do more of both and force choices about priorities to use the capital. It will also mean slower growth for the economy, and more difficulty in getting out of the slump, as it constrains bank balance sheet growth and therefore limits the amount of money in circulation. The regulatory policy is currently pushing against the monetary easing policy announced.

They will continue to devote a lot of effort to micro regulation – seeking to regulate each transaction and customer relationship – as well as putting more emphasis on high level or system regulation. Before and during the crisis the authorities had the powers necessary to demand more cash and capital but failed to do so. It was not a lack of power, but a lack of judgement which led them to permit the excessive build up of debt and books of financial instruments which characterised the period 2003-7.

We need to ask will they be any better next time round? The issue is do the regulators have a leader or top officials with both the judgement and the confidence to use that judgement to control bank balance sheets sensibly? It does not require more people or new armies of number crunchers. You can do it by just examining the balance sheets of the top half a dozen UK based large banks. Any annual reading of those between 2000 and 2007 should have told the informed reader that leverage was getting out of control. In say 2005 the regulators should have asked banks to raise more capital, keep more cash, or rein in their lending levels.

Today the regulators should not be raising their demands for cash and capital immediately. They should give the banks time to adjust their balance sheets, sort out their past bad debts and get their costs under control. The central Bank should be prepared to act as lender of last resort to ensure all the main banks have access to cash should they need it. The time to demand more cash and capital will come when we see money growth and bank balance sheet growth spurting ahead again. Instead of hiring a new army of regulators and inventing a new sequence of regulations, we just need one or two people at the top of the system with judgement and confidence. They already have quite enough power to do the job. The worry is the West will hinder its recovery with too much inappropriate regulation, leaving the field more open for eastern competitors. We should also expect continued policy lurches, as the authorities have still not restored normality to interest rates, money markets or banking.


  1. Stuart Fairney
    July 3, 2009

    The so-called NINJA loans (No income, no job or assets) which seem to have been at the source of the US crisis, far from being the actions of “spivs” or “greedy bankers” were of course aided by Fannie and Freddie and then federally mandated by the communuties reinvestment act which forced banks to make these loans. So regulators, far from being the solution, were indeed the problem.

    Add that to the fact that if you are now the chief exec of a large UK bank, you may as well say “To hell with prudence in long term sound money, let’s lend, lend, lend; the government want this at the moment and anyway if we go insolvent, we’ll just be bailed out, meanwhile I’ll walk away with a few years of bonus money”

    By contrast, if the government stay out of the market save for absolutely minimal regulation, and let banks fail if they go bust, the banks may conclude that it is in their own interests to be prudent. This is the best way to ensure banking probity in a way that an army of civil servants never can.

    1. Bazman
      July 3, 2009

      I agree absolutely in minimal regulation. This idea of creating markets where they do not exist is absolutely absurd, Take the railways and power….. Housing? Do not get me started. luking aftr ya m8ts. Cameron in a nutshell.

      1. Stuart Fairney
        July 4, 2009

        You belive the housing market does not exist??

  2. Mick Anderson
    July 3, 2009

    We need better regulation, not simply “more” or “less”, although less politics in it would be desirable.

    There should be an equivalent to the Glass Steagall law, so that investment banks could go to the wall if they fail, but retail banks were protected. All customer cash in the latter should be fully protected.

    Any investments (pension funds, &ct) using the investment banks as part of their portfolio should be obliged to specifically delare the exposure to the client.

    The tripartite system was always palpable nonsense – too many cooks. Lodge the responsibility in an identifiable place. Perhaps the BofE for the investment banks, and the Treasury for the retail banks, if you consider that one organisation can’t deal with the whole lot.

    Make Building Societies more identifiable (less like banks!); run for the members. They should be lending out money lodged with them by their savers in the local community, not borrowing on the commercial money markets.

    Reduce the multipliers that the retail banks can lend against (I really hate ‘deleverage’ as a word). Make them rely on their own due diligence when lending money out, rather than trying to hide behind an insurance policy. Boring retail banking was a very effective damper for a lot of years – let’s have it back.

    In short, make these organisations responsible for the consequences of their own actions. If a bank too big to fail, it’s too big to be allowed the freedom to make a significant mistake.

  3. Waramess
    July 3, 2009

    All of todays posts are most eloquently covered by the following:

    A real must for anyone with ten minutes to spare

  4. DBC Reed
    July 3, 2009

    Can we be sure that just looking over the balance sheets of banks annually will be sufficient to identify problems?
    Nobody remembers the Barings debacle,which should have given the banking industry advanced notice that respected institutions could be hollowed out and the evidence concealed : in advance of the Credit Crunch that is.
    Conceivably the sub-prime backed toxic assets whose implosion started the Credit crunch proper,would have appeared quite reliable on balance sheets since they had received triple A ratings.
    It is difficult to see what the regulatory authorities over here could have done when so much worthless paper was being produced in the States and pushed round international markets .

    Reply: It is not easy preventing or spotting a Barings style collapse, where things went wrong within the bank itself and where the official figures do not reveal the damage until it is too late. It took the Board by surprise, as well as the regulators.The overextension of credit by most banks in 2005-7 was in contrast easy to spot from annual published figures. The off balance sheet items were clear, but more importantly the on balance sheet items were excessive.

  5. […] John Redwood MP has written about financial regulation: “The issue is do the regulators have a leader or top officials with both the judgement and the confidence to use that judgement to control bank balance sheets sensibly? It does not require more people or new armies of number crunchers. You can do it by just examining the balance sheets of the top half a dozen UK based large banks. […]

  6. Alan Wheatley
    July 3, 2009

    It seems to me that if credit rating is of any use it is another factor to be considered with respect to regulation.

    Is not credit worthiness inversely proportional to risk?

    Should those organisation that issue credit ratings be subject to regulation?

    Can those with the relevant knowledge shed some enlightenment on this topic, please?

  7. figurewizard
    July 3, 2009

    The fact that Northern Rock failed despite being dedicated mortgage bank does not reflect badly on the notion of a new Glass Steagall act. It was a badly run bank with a reckless business plan so it was not exactly ‘traditional’ in its approach to its business. The subsequent problems suffered by other mortage banks in the UK were as a direct result of the interbank credit crisis, heralded by Northern Rock not because they were reckless too.

    The overwhelming advantage of a Glass Steagall approach would be a significant reduction or perhaps elimination of banks that are ‘too big to fail.’ Had this been the case two years ago it would have been a lot easier to ring fence individual problem players without calling the whole system into question. This would of course be even easier to accomplish if a strengthened and suitably empowered Bank of England were to have sole responsibility for it. No tripartitie regulation would then mean no chance of buck passing.

  8. Adrian Peirson
    July 3, 2009

    Living in Modern Britain is like trying to swim in Treacle, why can’t they just leave us alone, oh I forgot, Socialists Communists do not believe in personal freedom, every aspect of our lives has to be micromanaged.
    It would be interresting to find out what actually went on in their childhood that makes them crave such absolute control over other peoples lives.

    1. alan jutson
      July 3, 2009

      “It would be interesting to find out what actually went on in their childhood that makes them crave so much control over other peoples lives”

      They probably used to kill spiders, ants, snails, and the like for fun, then moved on bit by bit to try and control other peoples lives.

      It sad but true, that this is how some of the worst criminal minds started to develop, its all about power and control which gives them a high.

    2. Bazman
      July 3, 2009

      Errr! The taxpayer. These communist socialist fools.

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