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Banking Reform

November 7, 2011

In the wake of the banking crisis there were of course calls for reform. The reforms suggested by those accepted as mainstream include:
a. The separation of retails from ‘casino’ banks, so that the latter could be allowed to fail.
b. Higher capital and / or liquidity ratios: This is the kind of measure covered by the Basel Accords. The
report of the Independent Commission on the Banking System [ICB] suggests that equity capital (capital after
provisions and subordinated debt) should be used in the capital ratio.
c. All new derivative securities should be traded through a central counter party (i.e. on an exchange) so that
regulators know what’s going on; also all existing (unregulated) over-the-counter (OTC) contracts should be
registered with a central authority for same purpose.
d. A structure should be instituted for monitoring nascent asset bubbles – especially land, house, and stock prices
e. Separate the roles of monetary and macroprudential policy.
f. Regulate the structure (though not the level) of bankers’ pay.
g. ‘Lean against the wind’ interest rate policy – that is to say use interest rates in good time to check asset price inflation, not just consumer price inflation.
h. Time varying Capital Requirements
i revision of risk weightings in setting capital requirements

Other suggestions have been made by those not considered mainstream, and therefore largely ignored:
i Direct quantitative controls on the amount of credit extended by banks for defined purposes, sometimes referred to as ‘window guidance’. Such controls were widely used in the Bretton Woods era (1944 to early 1970s) by Western economies and since used successfully in various Asian economies. These have been advocated by Werner [e.g. Werner 2010] and Lines [Lines 2011].
ii Development in the UK of a healthy local banking sector, which amongst other things would be better placed to judge viable business loan propositions than the current multipurpose large banks.[Werner 2010] Local banking is much more prevalent even in the USA than in the UK.
iii Monetary Reform [e.g. Positive Money/NEF/Richard Werner]

The Independent Commission on the Banking System (ICB) first met on 9 July 2010, and published the issues paper in Sept 2010, inviting responses. My reading of the terms of reference suggests that it could have covered all the above suggestions. However there has been no reference at all to Werner’s submission, either in the interim report (April 2011) or the Final report (12 Sept 2011). There was a mention of monetary Reform in Annex 1 to the Interim Report, but no other mention. Why is this? It could simply be that the secretariat, which was made up of young Treasury staff did not draw attention to these submissions purely because thet did not fall into the current orthodoxy. We cannot find out because the ICB is not subject to the Freedom of Information Act. Why not?

The ICB recommendations on structure related mainly to ‘ring fencing’ a watered down version of separation of retail and casino banking. On macroprudential policy it mentioned only capital ratios. Its recommendations on competition were also weak.

In the meantime the government had established the Finance Policy Committee (FPC) to look after macroprudential
policy. Lord Turner is a member. Bearing in mind that in his 29 Sept speech he appeared to support ‘window guidance’ [Turner Sept 2011] there appeared to be no mention of this in the minutes of the second meeting of FPC on 20 Sept 2011 [FPC2]. In fact their thoughts on macroprudential tools seemed very vague, bearing in mind that a Department of Macroprudential policy was in existence at the Bank of England in 2009, this is very disappointing. The next meeting is set for 23 November. No further meeting dates have yet been published.

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