A step too far for the FSA

It’s a bit obscure, I admit, but I’ve been trying to decipher a speech that Lord Adair Turner gave to the Reserve Bank of India in Mumbai, earlier this month.

It wasn’t that his speech was desperately opaque but reading between the lines it left me wondering if the chairman of the Financial Services Authority was looking forward to a new era of super regulation where the demarcation between regulation, as an administrative function, and giving direction to the economy, as an executive function, becomes even more fudged than it is today.

Given that the FSA is already trying to micro-manage even the relatively safe building society and narrow banking sector, the creation of a super regulator, if it came to pass, would concentrate an awful lot of power and responsibility in the hands of one office.

According to Lord Turner, the recent global financial crisis was “rooted in over- exuberant credit extension in developed markets, and in the development of complex and opaque forms of securitised credit and of new and risky forms of maturity transformation”.  

Few could argue with that or his assertion that there’s growing agreement about the regulatory changes needed to create a more stable system, such as higher bank capital and liquidity and more capital against trading books.

But, he added, these responses did not address more fundamental questions such as the macroeconomic impact of volatility in the supply and demand for credit. To address this he proposed that developed countries should consider macro-prudential tools to control credit expansion – particularly in an upswing.  

This, he suggested, could be done by counter-cyclical variations in banks’ capital or liquidity requirements (a development already in progress with the revision of the Basle II protocol) but it appears that he wants more tools in his kit bag than just a revised Basle 11.

In particular, he advocated a variety of levers focused on “putting sand in the wheels” of short-term speculative trading, including increasing capital against bank trading activities. But he also seemed keen on transaction taxes, despite the practical difficulties of implementing them.

“The sensible conclusion on the overall benefits of increased financial activity, liquidity and innovation”, he said, “is that it is valuable in some markets, but not in all markets and not limitlessly.

“The problem for regulators and central bankers is that this conclusion does not provide us with nice easy answers on which to base policy.  It is much easier to proceed in life on the basis of a clearly defined and simple credo which provides the answer to all specific issues.  But it is more likely produce good results if we live in the real world of complex trade-offs and of relationships which are true up to a point.”

That may or may not be true but to date and to the frustration of many lenders, the FSA has often been unable to deliver clear answers to simple questions on an operational level and achieving complex trade offs within the context of global and national trends might just be a step too far, even for the masterminds at the top of the bureaucracy.

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