FOR Scotland's financial sector, heavily reliant on the health of its banking giants, it is hard to know which is more depressing: the fall-out from the credit crisis or the response of the Financial Services Authority: a £15 million budget increase
to hire 100 regulators.
I do not doubt bold steps need to be taken to cauterise this crisis. But hiring more inspectors at the FSA will prove, I fear, about as useful to sorting out the banks as recruiting piano tuners for the Titanic.
The FSA was the agency that developed a voluminous set of Conduct of Business rules. It codified almost every activity in the financial services industry. But it was unable to prevent the split capital investment trust debacle, the promotion of "precipice" bonds or more recently the boom in "mad mortgages" – 125 per cent loan-to-value ratios and advances on salary multiples that would have been considered crazy ten years ago.
This Napoleonic code book proved so fiendishly complex and ineffectual that the obsessive attention to rules was dropped in favour of a principles-based approach.
Has the FSA learnt the lesson? Clearly not. The herd-like stampede for more rules-based regulation is underway – just as banks have now hastily withdrawn their wilder mortgage products and so tightened their lending criteria as to bring a return of mortgage queues before a single new recruit has been signed up for Hector Sants' new model army.
I rather fear that by the time the hundred new regulators are hired, trained, and at their desks the big political issue will be how to relax lending criteria to give the economy a boost.
I am a sceptic on ever more regulation. Rules, no matter how encyclopaedic, can ever replace judgement and the sanction of caveat emptor. But I believe major changes need to be made to the conduct of monetary policy and the way in which lending institutions operate. I list six changes here. Not one of them involves the recruitment of an extra body to the FSA.
• First must be a recognition of the contribution that the government and the Bank of England has made to inflating the housing asset bubble and to the surge in lax lending. Much has been made of the "success" of the Bank's Monetary Policy Committee in "holding down inflation". This is not quite accurate. It held down inflation as measured by the Consumer Prices Index, which has no housing component whatever. Thus, the MPC was able to lower interest rates and maintain a low interest rate regime for the past five years while the housing bubble continued to inflate unchecked.
The borrowing binge and the growth in off-balance-sheet lending swelled the rate of growth in broad money. The CPI was adopted as a step towards making us more aligned with the EU and, to be fair to the Bank, many within it have been deeply uneasy over this change for the reasons cited here. At the top of my action list would be changes in the conduct of monetary policy which would recognise the behaviour of asset prices.
• Second, there should be a return to the tradition of central banks imposing mandatory liquid asset ratio requirements on their banking sectors as a quid pro quo for the provision of lender of last resort facilities. Before the introduction of Competition and Credit Control in 1971, British clearing banks were meant to retain an 8 per cent cash ratio and keep another 20 per cent of their assets in government debt with a maturity of less than five years. The re-imposition of modest mandatory reserve asset requirements (say, 5-10 per cent of eligible liabilities) might lower the growth in bank profits, but would help avoid the liquidity freeze we have seen in recent months.
• Third, it would help if lending institutions enforced existing prudential lending standards before rushing to invent new ones. In the US it now appears that a significant element of sub-prime mortgage lending involved rule suspension and outright fraud by the mortgage broker and customer. While I do not believe this rule-bending was as severe in the UK, it would help if mortgage advisory fees and commissions were paid, as insurance policy fees are paid, on a formula based on years in force and not simply on the initial sale.
• Fourth, government needs to do much more to encourage saving rather than borrowing, particularly with the savings ratio falling last year to 2.6 per cent, the lowest level since 1959.
The tax threshold for income and capital gains earned on savings out of taxed income needs to be raised substantially. For example, the existing ISA annual allowance of £7,200 should be lifted to £20,000, and for cash ISAs from £3,600 to £10,000. We need to promote a savings culture, not a borrowing binge.
• Fifth, responsibility for bank supervision should be returned to the Bank of England. While its monitoring regime was by no means perfect, it was able to draw, far more than has been evident at the FSA, on market information and informal warning signals rather than waiting for some wretched compliance form to be completed. The Bank was also able to put lending institutions on regular watch and to operate a more nuanced compliance regime.
• Sixth, there should be greater clarity on lending terms and conditions, with key points highlighted in plain English. Too often terms, charges, rules and conditions for mortgages and credit cards are set out in annexes of tiny type that encourages ignorance and complacency among borrowers.
Should bank executive pay be controlled? No. Much will be made of Adam Applegarth's £760,000 pay-off at Northern Rock and rather less, I fancy, on the £1m plus salary now being paid to Ron Sandler as executive chairman and the £900,000 a year to the new chief financial officer. Since these are rates approved by the government which is now NR's shareholder, it doesn't suggest state control of bankers' pay necessarily means less of it.
The full article contains 1035 words and appears in The Scotsman newspaper.
