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Lord Turner, Chairman of the Financial Services Authority (FSA), said that reforms to the regulation and supervision of individual financial firms need to be combined with new macro-prudential tools to guard against the risks of future financial instability.
Speaking at the CBI annual conference, Lord Turner recalled that when he was Director General, the CBI had argued successfully for low and stable inflation and liberalised markets, but that the combination had not ensured financial stability. This was because of two mistaken assumptions: first, that low and stable inflation was sufficient to deliver financial stability; and second, that efficient and rational markets will allow only useful financial innovation to flourish.
He said that:
"Low and stable inflation is essential but does not by itself guard against the dangers of volatile credit supply which cannot be analysed well or addressed effectively either by a central bank focused solely on an inflation target, nor by a regulator seeking to ensure individual firm stability through a firm-by-firm approach."
Lord Turner stressed the need to develop new macro-prudential tools such as through-the-cycle changes in capital or liquidity requirements. He welcomed the Bank of England’s recent discussion paper setting out a range of possible approaches. He said that implementing these tools will require close working relationships between functions currently located in both the Bank of England and the FSA.
In his closing remarks Lord Turner welcomed the CBI’s engagement in the issue of how well the banking system is equipped to serve all the needs of a vibrant economy.
"A debate about the economic value and the effectiveness of the financial system should”, he argued, “not focus solely or even primarily on a new-found willingness to challenge potentially negative aspects of the pre-crisis financial system. Instead, it should focus on the positive functions that banks and other financial institutions must perform in a successful economy – the not only socially useful but vital functions of linking savers to productive investment, allocating capital to efficient use, and providing savings, credit and payment products to individuals, companies and institutions."