Thursday, October 1, 2009

Where should we put the FSA?

Wouldn’t it be great if the hot air about bank reform could be captured as green energy – two problems solved in one! But as the bank reform debate drags on, the possibility of using the financial crisis post-mortem to rebalance the economy in favour of more socially useful activities – such as R&D, climate research, public services or even public sector deleveraging – is fading slowly away.

Today’s CSFI roundtable on bank regulation was attended by many former bankers, regulators and City grandees, but pitifully few senior private sector bankers.

Topping the speaker bill was a senior banker and former Bank of England director, who opened the debate arguing that the FSA be brought inside the Bank of England, and made one of three Bank of England subsidiaries. The other two would be the MPC, which should continue to set interest rates independently, and a Committee for the Supervision of Stability of the Financial System, which he said would monitor systemic risk and contain a representative of the treasury.

His main idea was that the different agencies could more easily speak to each other and share information, something that had not happened in the run up to the current crisis. For example, should the FSA detect a surge in mortgage lending and be concerned about the development of a housing asset bubble, it could tell the MPC and the CSSFS so that either interest rates or capital requirements for mortgage lenders could be raised to interrupt the bubble’s development.

Critics say agencies can communicate without being part of the same entity. They didn’t in the past, but that doesn’t make it impossible now. Another concern is that combining the bodies for micro and macro supervision would encourage regulatory groupthink, while a final concern is that in setting interest rates, the MPC should keep some room to manage its unavoidable conflict with social policy goals, especially as unemployment rises.

A more pragmatic criticism is that legislating to move the regulatory furniture is easy to do badly and should be done v-e-r-y slowly. “Any disruption is disadvantageous,” said the banker with understatement, especially in the recovery phase of the crisis. Hopes are that an incoming Tory government would delay implementing its proposals to re-house the FSA inside the Bank of England until it has done a thorough consultation, given the apparent train wreck that resulted when New Labour rushed its proposals through in 1997.

A Tory MP chipped in that the only change needed was the appointment of a “wise enough” bank of England governor. “It’s flaming obvious,” he said, before attacking Mervyn King for easing monetary policy when asset bubbles were forming and tightening it when liquidity was under threat.

Whatever the structure, the debate provides a nice distraction from the bigger and far more interesting debate about what shape banking itself should take in the post-crisis world. John Kay’s proposals for Narrow Banking were sadly sidelined by talk about the Bank of England/FSA holding structure. This is not a surprise as vested interests are strong in the City and such radical ideas tend to be deflected, especially with cries about protecting the City.

One bank apologist, a consultant, went so far as to say that narrow banking was “beyond the ken of most honest people”. He then went on to argue that Goldman Sachs’s return to profitability proves that the system is not broken (just don’t mention the USD 10bn bail-out money and the rescue of AIG).

Also absent from the debate was the role of international surpluses and balance of payments; whether OTC products should be controlled; how quickly should capital requirements be publicised so that banks have time to meet them; and, of course, bankers bonuses.

The overall mood was that most want reform of some kind, but vested interests make the appetite for radical reform much weaker than it should be. Instead of deciding who reports to whom in the regulatory organogram, the City now needs a proper debate on its own purpose and structure. Without it, we risk either a rushed and populist reform agenda, or a missed opportunity that will condemn us to a repeat crisis a few years from now.

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