Connected Research

Union policy research in the 21st century

Adair Turner – FSA heretic

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Selected extracts from Adair Turner’s Mansion House speech given last night:

…Hundreds of thousands of British people are newly unemployed; tens of thousands have lost houses to repossession; and British citizens will be burdened for many years with either higher taxes or cuts in public services – because of an economic crisis whose origins lay in the financial system, a crisis cooked up in trading rooms where not just a few but many people earned annual bonuses equal to a lifetime’s earnings of some of those now  suffering the consequences.  We cannot go back to business as usual and accept the risk that a similar crisis occurs again in ten or 20 years’ time.

We need radical change.  Regulators must design radically changed regulations and supervisory approaches, but we also need to challenge our entire past philosophy of regulation…

… not all financial innovation is valuable, not all trading plays a useful role, and … a bigger financial system is not necessarily a better one. And, indeed, there are good reasons for believing that the financial industry, more than any other sector of the economy, has an ability to generate unnecessary demand for its own services – that more trading and more financial innovation can under some circumstances create harmful volatility against which customers have to hedge, creating more demand for trading liquidity and innovative products; that parts of the financial services industry have a unique ability to attract to themselves unnecessarily high returns and create instability which harms the rest of society…

… So the FSA, on behalf of society, must consider whether the financial services industry is delivering its vital services in an efficient and risk-controlled fashion… [This]… impl[ies] an important and profound shift in regulatory philosophy…

… It does mean that the top management of banks… need to operate within limits.  They need to be willing, like the regulator, to recognise that there are some profitable activities so unlikely to have a social benefit, direct or indirect, that they should voluntarily walk away from them.  They need to ask searching questions about whether the complex structured products they sold to corporate and institutional customers, truly did deliver real hedging value or simply encouraged those institutions into speculative and risky exposures which they did not understand: and, if the latter, they should not sell them even if they are profitable.  They need to be willing to accept the capital and other requirements which will be imposed on activities of little value and considerable risk, rather than deploy lobbying power to argue against such constraints on the basis of a simplistic assertion that all innovation is always valuable.

Powerful stuff.

The regulatory reform Turner spoke of refers to a number of issues:

– a requirement for the global banking system to be more prudent and to operate with larger shock-absorbing buffers of capital and liquidity

– the imposition of much higher capital requirements against many riskier trading activities and a bias towards conservatism in the capital requirements for trading in complex and potentially risky products where the benefit to the economy is unclear.

– a far more assertive style of supervision, no longer willing to assume that market discipline and incentives will always lead bank management to make optimal decisions and one more willing to make judgements on whether business models and business strategies create undue risks for the whole financial system.

Perhaps a quiet, rather than profound, still less radical, reform.

Nevertheless, Turner also had words to say about banking bonuses, reminding his audience that new FSA rules require remuneration committees to make a key part of their consideration the risk consequences of remuneration structures and of the need to get these structures right for the long-term. In particular, banking bonuses need to be consistent with the priority of using the extraordinary profits now arising to rebuild the system and, that, long-term regulators will have a ‘legitimate interest’ in aggregate bonus payment rates ‘if and when these payments have implications for capital conservation’. So, banking bonuses are also part of the reform programme.

Turner appears not to have been carried out to Smithfield and burned but the level of apoplexy in the room at his address and the issue of reform can be imagined. But, at the very least, kudos to Turner for entering the lion’s den and reminding people that, ahead of the G20 meeting later this week, far from a return to ‘business as usual’, much of what bankers do remains contestable in terms of public policy.

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Written by Calvin

23/09/2009 at 12:09 pm

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