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For months, the best banks could hope for was to survive on life support until they woke up in a nightmarish world of intrusive regulation. And here it is. The Turner review, an attempt by the UK’s Financial Services Authority to explain how it intends to make banking safe for society after the worst financial crisis in a century, is a call to co-ordinated action to regulators round the world. Much of it is unarguable. The banking system must operate with more and higher quality capital, with the amount set against casino-like trading bets raised as much as threefold. The future world of banking will be one of lower average return on equity, but significantly lower risk to shareholders and depositors.
Equally sensible is a proposal for a new capital adequacy framework that offsets the pro-cyclicality of Basel II with counter-cyclical provisions parked in a new “economic cycle reserve”. Introducing capital buffers that expand in economic upswings and shrink in recessions should allow the system to absorb economic shocks rather than amplify them. As a backstop, the FSA also proposes to subject bank capital adequacy to a common sense test in the form of a maximum gross leverage ratio, similar to a scheme Switzerland recently introduced to encourage rapid downsizing of the large trading books of its universal banks.
The FSA has done well to warn hotheads against the superficial appeal of barring “utility” banks from “investment banking” activities: large, complex banks spanning a wide range of activities must remain a feature of a globalised trading and financial system. Given the political hysteria over pay, its statement that poorly structured bonuses were “considerably less important” in provoking the crisis than inadequate approaches to capital, accounting and liquidity is commendably honest. Targeting pay excesses indirectly is also sensible. The stiff increase in capital required for trading activity will do more to moderate pay than micromanaging remuneration ever will.
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