The King Speaks - Bank of England Governor Advises More Regulation is Not Enough

by Karl Hindle, London UK

“Never has so much money been owed by so few to so many.”

Paraphrasing Winston Churchill, Mervyn King, Governor of the Bank of England, emerged from his almost deafening silence this week with an announcement on bank and financial reform which seems revolutionary if not, downright rebellious!

At first sight that is.

Mervyn King is a past master at timing and the delivery of the oratorical coup d’grace; this week’s developments will only enhance that reputation and especially as Lord Turner and the FSA are due to unveil their views on regulatory reform next week.

King took the opportunity to give forth to his views at a gathering of Scottish business organisations on Wednesday evening.  The full text of his speech is found here.

King’s view is that banks must split their traditional functions, which are vital to effective operation of the economy, from other, riskier money-making activities.  Regulation is simply not enough. In a simple yet elegant statement, King demonstrated his command of the “Big Picture”;

"The belief that appropriate regulation can ensure that speculative activities do not result in failures is a delusion."

Strong words indeed, but we ought not to be so surprised as, after all, it was King who baldly stated to the Commons Select Committee much earlier this year;

“If a bank is considered too large to fail then perhaps it is simply too large.”

King has rightly identified a glaring weakness in financial and banking regulatory reforms; banks, and indeed any company, will continue to take risks and engage in even riskier behaviour, if they believe they are too big to fail and will be bailed out by the taxpayer.  Bailing out banks has reinforced the belief that no matter what they do, a big bank will not be allowed to fail and this belief will undercut any true commercial risk assessment and whether to take that extra risk on.

While the G20 called for much tighter regulation of the banking and financial sector, backed by higher capital adequacy levels, King is still concerned.  Achieving regulatory compliance will only tackle the symptoms of the disease and not tackle the underlying causes of the crisis.  It’s a brave observer who is prepared to state this in the face of overwhelming G20 consensus that regulation is the answer, but King has delicately and exquisitely placed his finger on the problem.

Governments wish to reduce risk inherent in the banking and financial system, which sounds like a good idea except, actually what they really are looking for is to reduce the risk the economy is exposed to by the banking sector.  If a bank wishes to diversify into so-called “casino banking”, such as hedge fund management or other alternative activities, so be it.  If it fails, as far as the economy and taxpayers are concerned, it is of no consequence.  King’s view is that such a bank should not be allowed to back that risk by using the financial position gained through traditional banking business vital to the economy and global financial system.  Traditional activities such as holding savings and loans, have been used by big banks to effectively diversify away the “casino” risk onto the taxpayer as they will be bailed out. 

King wants banks broken up so the riskier segments cannot be allowed to piggy back on traditional, economically critical activities.

I think King is absolutely right.

No amount of regulatory reform is going to tackle the problem that we have created for ourselves.  The banking sector may have had an exceptional jolt, but they have been bailed out with relatively few casualties by taxpayers around the world. The lesson has been taught and no doubt learned, the taxpayer will bail out risk takers who ought to have stopped assuming risk a long time ago.

Next week is Lord Taylor’s turn and I predict it will be a rerun of previous “guidance and pronouncements” with a layer of gloss to meet G20 commitments.  Expect accusations of displaying little imagination or “Blue Sky Thinking” which Turner is known for; did I mention King has impeccable timing?

From a UK big bank perspective, if King wants a large-scale break up of big banks and Turner wants more and more regulation, it is time to be afraid… be very afraid!