28 March 2012

Peter Sands: The dangers of our new regulation

Before the crisis, financial regulation focused on averting the failure of individual banks, and wasn’t much good at that. Now there’s much more focus on preventing systemic crises. In the jargon, we’ve moved from focusing on “micro-prudential regulation” to a much greater emphasis on “macro-prudential regulation”. In the UK, this shift has resulted in the creation of the Financial Policy Committee, which has just published its thinking on the powers it wants, and the tools it intends to use.

It might not be obvious from the somewhat technical language, but in effect the FPC wants to control how much lending there is in every aspect of the economy, from manufacturing to mortgages, and how much it costs. Even if the FPC had the perfect combination of skills and insight among its membership and all doubts about accountability were swept away, I think this notion that one committee should be able to anticipate all risks and micro-manage such an important part of the economy is dated and wrong. History suggests direct command and control is as flawed as complete laissez faire.

Second, the FPC seems remarkably insouciant about what investors in bank equity and credit will think about their interventions. Put bluntly, if investors can’t be convinced that investing in banks will deliver appropriate returns, capital will be sucked out of the industry, causing credit availability to fall and the cost of credit to rise. This is not what we need when economic growth and job creation are the priority.

What worries me as well is that the FPC seems blind to some of the biggest risks to financial stability. Look at the Bank of England, the Federal Reserve and the European Central Bank. All three have seen a huge expansion in their balance sheets, are much more leveraged, and have deployed innovative tools on an unprecedented scale. Central banks are in new and uncharted territory, with unpredictable and potentially profound consequences.

Surely these issues should be on the FPC agenda? Maybe they are, but you won’t find mention of this in the minutes of their meetings. In the world of the FPC, it appears that governments, regulators and central banks are paragons of virtue, the private sector the source of all problems. Tell that to the people of Greece. Fiscal irresponsibility and loose monetary policy were important contributors to the crisis, alongside the fact that some banks did behave extraordinarily stupidly and recklessly. To avoid further such crises, we need the FPC to be unblinkered and courageous, sweeping in its scrutiny, deliberate and thoughtful in action.

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