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King calls for simple and robust regulation

In a speech to the Worshipful Company of International Bankers last night, Mervyn King, governor of the Bank of England called for regulation to be simple and robust.

He says recent years have seen a natural experiment with some regulatory systems offering a light touch and others offering a heavy touch.

He says: “Yet they all failed to some degree to prevent the accumulation of risks that finally produced the crisis.”

He says because charges are often structured so that investment managers receive more of the upside from risky behaviour than they share in the downside, they have an incentive to promote the risky investment strategy.

He adds: “That, allied to a massive increase in the complexity of financial products and instruments in recent years, has meant that investors have, perhaps unwittingly, aided an enormous increase in the risks being run in the financial system.

Given these problems, he says regulation should aim to be simple and robust.

He says: “Overly complex measures of risk and capital adequacy are rarely robust to developments that are easy neither to anticipate nor calibrate. And robust rules for regulation will of necessity need to be simple or supervisors will be lost in a morass of unnecessary detail.”

For the same reasons he says we should not expect too much of regulation.

He says: “Conventional judgment is a safe haven for bankers and regulators alike. It is not easy to persuade people, especially those who are earning vast sums as a result, that what looks successful in the short run is actually highly risky in the long run.”

King says it is unlikely that prudential supervision can be implemented as a set of rules to be applied mechanically.

He adds: “Nevertheless, to rely solely on the discretionary judgment of individual bankers and regulators is asking too much of human capabilities.”

He continues: “We need to build into the system some simple and robust impediments to excessive risk-taking that can be monitored. And we must ensure that an institutional memory is maintained so that the lessons from the crisis are not forgotten and those impediments to excessive risk-taking are not swept away once memories of the crisis recede.”


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