FSA chairman says: 'no silver bullet' to address 'too-big-to-fail' challenge - appropriate capital requirements are not the only solution
05 November 2009
Lord Turner stressed that the answer lies in a combination of different policies, in particular, higher capital standards, the need to reduce inter-connectedness in derivatives markets and the development of firms’ resolution and recovery plans.
Reviewing the range of options for dealing with large systemically important banks, Lord Turner argued that several had achieved consensus support, in particular, higher capital standards, the need to reduce interconnectedness in derivatives markets and the development of firms’ resolution and recovery plans (‘living wills’).
Lord Turner, therefore, focused on two issues where controversy still remains, namely, the narrow banking debate and the appropriate approach to the risks created by cross- border operations.
Addressing ‘narrow bank’ proposals which seek to separate utility banking from casino banking, Lord Turner argued that an extreme narrow banking model, with retail banks investing only in government securities, was certainly practical but failed to address the crucial issue of booms and busts in credit supply, and as a result, could actually increase financial instability. But he suggested that the objectives behind a ‘new Glass Steagall’ distinction between commercial banks and proprietary trading were desirable and could be pursued by appropriate capital requirements and the use of resolution and recovery plans to drive internal distinctions between retail and trading activities.
Lord Turner emphasised that:
"It is essential to progress this argument beyond the top line slogans, for or against narrow banking, and get down to details. The extreme narrow banking proposal is clearly doable in practical terms, but I believe could produce a financial system even more vulnerable to instability than the one we have today. In contrast the ‘new Glass Steagall’ divide is in principle attractive, but arguably best pursued through the capital requirements we place on trading activities rather than through an attempt to write a law prohibiting some activities and allowing others."
Turning to the approach to large cross-border banks, Lord Turner said that a crucial issue was the appropriate balance between regulatory focus on whole group capital and liquidity versus focus on the soundness of standalone national subsidiaries. He argued that the more standalone approach could be an answer to the “too-big-to-rescue” challenge. If each country was responsible for resolving problems in the local operations of a global group, rather than responsibility resting solely with the home nation of the group’s headquarters, an inevitable consequence would be host countries imposing stronger local capital and liquidity standards, creating standalone national subsidiaries. Whilst some commentators have argued this could lead to a harmful restriction of capital flows, Lord Turner said that this has not been demonstrated and that authorities in several emerging markets believed that standalone national subsidiaries helped guard against harmful volatility.
Lord Turner concluded:
"It is important that these ideas are challenged and others put on the table. This is why the paper we produced on 22 October is a discussion paper not a conclusions paper, and why we hope, through this conference and subsequent initiatives, to stimulate a wide ranging debate on these complex issues."
© FSA - Financial Services Authority
