New rules must allow innovation

The rescue last week of Dunfermline will inevitably re-ignite the debate on the governance of regulated institutions.

While Dunfermline was clearly facing a uniquely difficult situation, its story is a vivid illustration of the dilemma faced by many smaller financial institutions in recent years.

From the late 1990s onwards, smaller players found their traditional habitat invaded by hungry new predators who mounted a challenge that many were ill equipped to meet.

Most firms saw their margins shrinking and some responded by assuming more credit risk.

This growing appetite for credit risk posed a toxic threat to those businesses that lacked the necessary expertise to select the right transactions and price them appropriately.

The benign trading environment in the first half of this decade lulled many lenders into a false sense of security, which only served to embolden them to assume more and more risk.

So where were the regulators while all this was happening? Whatever the explanation, it is clear that some lessons have been learnt by all the key stakeholders.

In future retail banks and building societies will be compelled to limit their risk appetite, simplify their funding models and strengthen liquidity and capital.

We can only hope there will still be room for the innovation and flexibility that has been such a positive feature of our market.