Crisis-proofing the banking system

Business district24 February 2012

Are lessons learnt, and can we avoid another global financial crisis in the future? While sceptics claim the banking system is 'broken' and regulating our way out is impossible, others argue that the right measures can ensure that another meltdown won't happen.

The huge cost of the crisis and the crucial role banking plays in national economies makes it vital to explore options to 'crisis-proof' the banking system. This was the topic of the recent National Institute of Economic and Social Research/ESRC conference 'Never Again?', which examined whether there has been progress towards a safer banking system.

A key challenge is to introduce the right amount and type of regulation – not least as these measures are imposed nationally, while the financial system is globally connected.

Financial regulation will require coherent international rules and improved co-operation amongst national authorities, said Professor Rosa Lastra, Queen Mary University. There is always a danger of 'fighting the last war', and measures such as greater transparency and accountability may sometimes be a better alternative to heavier regulation. Similarly, if we wish to achieve behaviour change, we need to strike the right balance between general principles and more detailed prescriptive rules, she pointed out.

We can't look to shareholders to prevent excessive risk-taking, argued Alan Morrison from Saïd Business School, University of Oxford; risk-taking is in shareholders' interest as long as they can rely on state intervention. Instead we could encourage institutional change through measures such as smaller and less complex banks, higher capital requirements and clear risk management rules.

The proposals of the UK's Independent Commission on Banking (the Vickers Commission) were questioned by Angus Armstrong, Director of Macroeconomic Research at NIESR. He suggested that the commission's recommendations risked a shift of banking activity towards the unregulated 'shadow banking' sector.

David Aikman from the Bank of England outlined plans for a restructured BoE, with the new Financial Policy Committee (FPC) taking responsibility for financial stability and complementing the existing Monetary Policy Committee (which targets inflation). The FPC will oversee two new bodies - the Prudential Regulation Authority and the Financial Conduct Authority. A key issue will be what policy instruments are available to the FPC, and how its activities interact with the MPC; to some extent it will be a case of 'learning by doing'.

Financial stability should not be the main goal, but rather the efficient supply and flow of credit, proposed Professor Alistair Milne of Loughborough University. Policies fixedly focused on a stable system could end up with a 'stability of the graveyard' - where the supply of finance to many enterprises and households is severely restricted.