Climbing Out of the Credit Crunch

Regulation

We do not believe that poorly drafted and inadequately implemented regulation is the main driver of the credit crunch and too great a focus on this area risks deflecting blame from specific banks and individuals concerned. Nonetheless it must be considered.

Retail banks have a fundamental role in society and both they and their depositors need protection. Arguably, investment banks do not need the same protection but most large banks now have both retail and investment banking activities in house. The issue is both that banks are now too big for regulators to ensure proper protection of all depositors, and the blurring of retail with investment banking. Only direct government action — and taxpayer bailout — of Northern Rock has stopped people losing their life savings. This in turn could have had a larger effect on society if the depositor base lost faith in the banking system. This leads to the issue of moral hazard, with banks being too big to be allowed to fail.

Clearer rather than heavier regulation is needed. A separation of retail from investment banking should be the regulatory goal.

Clearer rather than heavier regulation is needed. In the UK, we believe there is confusion over what the Financial Services Authority is trying to achieve and the extent to which it is committed to protecting the interests of consumers. Depositor compensation arrangements are not over–generous by international standards and addressing this might lead to increased public confidence in the banking system. Simplification of over–complex investment products would help, as would measures to increase financial literacy. On a fundamental level, the regulatory system must recognise that the relationship of bank and customer should be one characterised by trust.

To help achieve this, a separation of retail from investment banking should be the regulatory goal. Retail banks should be segregated from other financial institutions in terms of the activities they can engage in. Any new product that does not resemble a deposit or a loan to an individual or a corporate body should be presumed to be a non–retail product and not permitted. All banking regulatory bodies, nationally and internationally, should aim for this distinction as a key policy objective.

It is vital that the public know what they are putting their money into. Normal retail bank customers were not to know that banks were taking on wholesale market risks. There has to be a clear stratification of savings products. Transparency is key.

The capital requirements regime for banks should be reviewed. Consideration should be given to retail banks being offered more protection against crises in liquidity with larger buffers built into the Basel 2 framework. The adequacy of the close link between accounting numbers and regulatory capital also needs reviewing.

We would add one final point about regulation — credit ratings agencies do not have any sort of statutory regulation. Given their considerable role in the credit crunch, the industry has not been any sort of example for self–regulation. This anomaly should be addressed immediately and agencies brought into line with other players in the financial regulatory field.

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