Thursday, November 3, 2011

Bank of England wants to be left alone to police banks and not be restricted to a specific set of rules

If there is anything that the credit crisis has shown, it is that the Bank of England's Mervyn King understands the need to radically change the relationship between banks and their regulators.

In a Telegraph article, Mr. King discusses what he would like to see.
“What needs to change in the culture of regulation is to get away from this game in which the regulators write ever more complex regulation and the banks and their lawyers [create] new products which are the same essentially as the previous products but defined in such a way as to not to be caught by the latest rule and regulation,” the Governor said. 
Sir Mervyn said regulators should have the freedom to tell a bank: “Look, frankly, we don’t understand why your organisation needs to be so complex. We can’t work out what you are doing, so you’re going to have to change it. You haven’t broken a rule, but too bad, you’ve got to change it.” 
In short, Sir Mervyn recognizes that opacity in both financial products and organizational structure is a problem.  Fortunately, by requiring disclosure of all the useful, relevant information in an appropriate, timely manner, it is easy for the regulators to fix the opacity problem.

With disclosure, regulators can turn to market participants, including a bank's competitors, to try to understand both financial products and organizational structure.

If the complexity is too much for the market participants, it is a clear sign that a bank has to stop selling the product or change its organizational structure.
Addressing the Draft Financial Services Bill joint committee, ... The Governor said banks should be set up in a such a way that allowed them to fail. 
“Once regulators get bogged down in excessive detail they’ll never be a match for the banks.
Unless there is disclosure.  With disclosure, regulators can use other market participants so the regulators can match the banks in understanding what is going on.
So we have to have a framework in which most of these firms can fail. If they screw up, [then] we just let them go bust.” ...
One of the reasons I keep talking about the need for disclosure is that it prevents failure by imposing market discipline.

Yes, some banks will ignore market discipline and fail.  However, market discipline acts like a stop light and signals to the regulators to step in earlier to unwind the banks that insist on failing.
He added that when bank regulatory powers transfer to the Bank of England, it should be accountable to the public and to Parliament, but not the industry. “That’s the slippery slope to regulatory capture, which was one of the major problems leading up to the crisis,” he said.
Disclosure is the vehicle for preventing regulatory capture.  With disclosure, market participants can exert pressure on regulators to address problems before they become systemic.

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