Short Note - Financial Regulation in London

The Government has now published its white paper on the regulation of the financial services industry. This emphasises heavier capital and liquidity standards on banks that pose the greatest risk (are ‘systemically significant’) to the system.

As expected, although the Bank of England gets some extra powers, it is the Financial Services Authority that will be charged with drawing up the rules. The banks are also going to be directed into providing more education on financial matters to schools and the community at large.

The Proposals

The detail can be picked up easily enough off the internet or in the mainstream media but the main proposals are:-

• A Council for Financial Stability to review policies to smooth out the credit cycle, taking advice from the Bank and FSA and publishing its decisions
• The FSA will get statutory responsibility for financial stability with extended powers to suspend individuals and institutions
• A cyclical approach to risk management so that regulators give greater leeway to banks in times of crisis but reduce their risk-taking during the booms
• A general but not very concrete intention to improve consumer protection and market transparency
• No artificial limits to bank size or complexity: banks will be assessed on capital and liquidity
• The possibility of a new levy on UK banks to pre-fund the Financial Services Compensation Fund and so reassure depositors
• The promotion of increased diversity in financial services with a particular concern to encourage better governance in the mutual sector

Political Reactions

Both the Tories and the City Of London were quick to attack the Treasury’s proposals. The idea that the FSA rather than the Bank of England should determine capital levels was not regarded as credible. The Tories have promised root-and-branch reform of the system introduced by New Labour.

The Liberal Democrats have also consistently opposed New Labour’s regulatory proposal so that the weight of opinion in an election year means that the bulk of the system cannot realistically be implemented until after an election - and then only if New Labour wins a working majority.

For example, the FSA will find hard to bring in talent on decent commercial terms where ‘rising young stars’ may fear that their careers may come to an abrupt end with the return of a Tory Government.

The European Dimension

The drive towards regulation within the European Union is also beginning to unnerve particular interests in the City of London. There are two fronts in this war: banks and hedge funds. It is fiercely conservative Germany that is driving the push to force banks to strengthen their capital base.

The British banks are in a weak position to resist their own Government’s instinct to cave in to European sentiment but the hedge funds are putting up more of a fight with dire warnings that tough European restrictions on hedge funds might cause a regulatory war with the US. 

They claim that they cannot be held responsible for the recent credit crisis and that the proposals are either malign or ignorant. The details are technical and the lobbying can be suspect but there is no doubt that many influential Europeans deeply resent the freebooting City and want to bring it to heel.

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Squabbles Over Financial Regulation In London

The squabbles over financial regulation continue with four competing players: Treasury (Government), Financial Services Authority; Bank of England; and the financial services industry itself, backed by its own lobby organizations and the City of London.

The ‘aggressor’ in this case is the Bank of England which wants tougher financial regulation whereas the Treasury and the City worry that a regulatory turn of mind, in an excess of risk avoidance, might kill the goose that lays the tax and profits egg.

The Bank of England’s concern is probably more noble. It genuinely fears that, having escaped from economic meltdown by the skin of our teeth, we have no second chances and that a future crisis could break the back of the British economy.

A second crisis (though never said) may place the future of traditional British liberal capitalism in doubt. The FSA, meanwhile, is probably least noble in its concerns – protecting its turf from attempts by the Bank of England to take over many of its key functions and so displace the primary City regulator.

The FSA has, however, seen the writing on the wall, especially as the Bank has some US precedent behind it. An incoming Tory Government might very well adopt a similar tough line, if only because something decisive may need to be done by the incoming Chancellor for political reasons.

The FSA model is not to hand over powers to the Bank of England but for improved collaboration with the Bank through a financial stability committee. It is seeking co-dominion over City regulation. Much of this is bureaucratic self-protection and need not detain us for long.

More importantly, all this is another sign of the weakness of the New Labour Government in allowing these non-Governmental bodies to fight a turf war in public without settling the matter through edict.

The financial services sector is remaining cautiously and relatively silent except on the attempted coup against the City of London through a new EU Directive where it fears that a weak Government really will take its eye off the ball and allow a French knife to slice the goose's throat.

Bank and FSA are united in seeing bad behavior returning to the banking sector. They are now expressing, often indirectly, concerns at the effects of political weakness on policymaking as the immediate threat recedes.

Centrist governments and finance capital are already drifting back towards their old strategies of collusion.

The technocrats charged with the economy are getting worried that laziness and fear will mean no reform – and that no reform may mean that we will have to go through the whole crisis again at some later stage with much worse effects on the economy and perhaps the polity.

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Short Note - The State of the British Economy

Last week, there were fears (which we shared) that political weakness might drive sterling down. This has proved not to be the case – on the contrary, the pound surged on June 12th to its highest level in 2009 on the general market belief that the UK economy was recovering.

The analytical community is no longer depressed with the prospect of a prolonged recession. Others, especially manufacturers, remain more cautious – they see some of the recovery as merely technical and related to rebuilding of stocks with no real ‘roots’.

Pressures on the banks have certainly not gone away and, of course, apart from the general systemic risk, the State cannot afford to see a boom/bust in its revenues.

Lloyds Banking Group, for example, is taking a £450m hit on loans provided to pubs group Admiral Taverns, one of its biggest write-offs on a single investment. All the major banks are expected to have to write off billions of pounds in the next two years.

In this context, the expectation is that the Bank of England’s interest rate is likely to remain at 0.5% for some time even if the banks themselves may start to drive up their mortgage rates. A bright spot however (relatively) appears to be the City of London property investment market.

Half of its value has been wiped out since the peak in 2007 but agents have estimated that as much as £1bn of City deals, meeting the needs of cash-rich international buyers, are now working their way through the law firms.

Looking at the bigger picture, the recent economic crisis is seen as having three components – excessive mortgage lending, excessive consumer credit and excessive public spending. The first two have apparently been dealt with through the free market mechanism but the last remains on the agenda.

It is not only that public spending was financed by unsustainable borrowing but by tax receipts from a financial sector that is now no longer in a position to sustain the flow of cash into the public purse.

Banking regulation also remains on the agenda with a warning from the Treasury expected that the bankers are not off the hook amidst fears that, as recovery comes in sight, they are getting sloppy again.

What we are seeing now are the first shots in a political war between the Chancellor and the British Bankers’ Association over controls on liquidity and capital standards but political conflict does not stop there. The Treasury and the Bank of England are also in open conflict over approaches to regulation.

The Bank of England is adopting a tougher line even than the Treasury on City practice. The Treasury appears to be broadly satisfied with current regulatory structures and has resorted to exhortation about the improvements necessary in private sector governance.

Is the Government slipping back into the self regulatory model that clearly failed the country in 2007/2008? The Bank of England appears not to be happy – it want to see much tighter US-style regulation to pre-empt future problems and restore confidence in capitalism.

The Governor has now called for greater powers for itself and this raises interesting political issues given that the Liberal Democrats are supportive and the Tories seem to be moving in that direction themselves.

The threat to the uneasy alliance of New Labour with the City of London is only in its early stages but it has the potential to be disrupted if there is some further reason for the public to believe that the Government is unwilling or unable to protect it in a crisis.

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