Call for radical reform of UK banking system with no room for bailouts

News - Banking

Written by Ray Clancy

Monday, 29 March 2010 08:21

Financial institutions in the UK must bear the consequences of their own actions and the public will not stand for another bailout, according to a new report.

The assumption that some important firms, including banks, are too important to fail and will be rescued if necessary needs to change along with urgent radical reform of the system, says the report from The Treasury Committee.

‘Reform is particularly pressing for the United Kingdom, where the banking sector accounts for such a large share of the economy. During the financial crisis, governments have effectively stood behind the banking system. If international banking in the United Kingdom is to remain credible, reform must ensure that the tax payer is better protected from picking up the bill,’ said Treasury Committee Chairman John McFall.

The Report looks at the range of reforms currently under consideration, and assesses them against the objectives of an orderly banking system; protecting the consumer, protecting the taxpayer, setting an appropriate cost of doing business and providing lending to the economy.

It emphasises that successful reform would transfer risk away from Government and back into the banking sector. If moral hazard is reduced, market participants will have an incentive to apply market disciplines.

‘Given that the UK has just been through a financial crisis, the current desire is for a safer, more secure banking system. But the redesign of the system should be for the long term. We must not replace irrational exuberance with equally irrational restrictions,’ it says.

‘What is needed is a regulatory framework that will not flex according to the moods of politicians, the markets or even regulators. Given the lamentable consequences of the previous regulatory approach, the Government should be prepared to embrace radical change, rather than settling for adaptation to an existing, failed model,’ it adds.

The report is based on evidence given to the committee from a wide range of key international figures. ‘It is clear that many financial companies could and should improve their risk monitoring and their risk management but judgement will always play a role, and error is always a possibility, whether it be by firms or regulators. Thus the possibility of the failure of a bank, or number of banks, always remains. Indeed, over time, it is certain that such failures will occur. While it may always be desirable to reduce risk, the primary objective of reform should be to ensure that the system is resilient if failures occur,’ the report points out.

It says that higher capital and liquidity requirements may go some way to meeting the objective of an appropriate correlation between risk and reward. ‘However the financial crisis occurred despite repeated attempts to reform the capital and liquidity regimes. The lessons of this and preceding crises can be used to improve the capital and liquidity regimes, but that will at best be only a contribution to the wider structural reforms that are required,’ it continues.

‘We can never guarantee failures will not occur again. It is crucial therefore that in addition to improving risk management, regulation and raising capital and liquidity requirements, wider structural reform remains on the agenda,’ added McFall.

The report calls for the debate on banking reform to remain as wide as possible and the UK can only benefit from constructive international agreement but prevarication on international agreements must not be used as an excuse to delay, or, at worst, prevent reform. ‘We remain fully behind international agreement, as long as it is does not become an excuse to stave off reform. The size of the UK’s banking sector means that it is not to our benefit to have a fragile banking system. Where we can lead on reform, we should,’ said McFall.