Turner is right to take on swollen banks

August 27, 2009

So the watchdog can bark after all. Adair Turner, chairman of Britain’s Financial Services Authority, says the financial sector has “swollen beyond its socially useful size”. That is a striking statement for any financial regulator, particularly one that counts promoting London’s financial centre as one of its goals. Identifying the problem, however, is the easy bit. Reversing decades of financial expansion will require global agreement on tough new rules, and the determination to make sure they are consistently enforced.

Turner’s comments, in a debate hosted by Prospect magazine, underscore the extent to which the crisis has upended the received wisdom among policymakers. For years they assumed markets were self-correcting, that financial innovation brought lasting economic benefits, and that regulators should think twice before getting in the way.

But after two years of global economic turmoil and with several trillion dollars of public money committed to preventing further panic, the costs of this approach have become all too clear.

What is less certain is what should come in its place. A market economy needs functioning banks and financial markets to intermediate capital flows and allocate credit. This useful activity will involve some useless speculation: it is hard to imagine a regulator — or anyone else — reliably drawing a line between the two.

The authorities can, however, make sure that banks take greater account of the possible costs of their risk-taking. Turner thinks forcing banks, particularly those involved in trading activities, to hold greater reserves of capital will choke off some “socially useless” activity. Such changes are already under way. They will have the added benefit of reducing banks’ profits and — by implication — the outsized bonuses they distribute to employees.

Governments can also do more to protect taxpayers from future financial failures. Banks could be required to prepare for their own failure by drawing up what Mervyn King, governor of the Bank of England, memorably described as a “living will”. Alternatively, systemically important institutions could be charged an explicit fee for the state guarantee they enjoy.

Turner also floats the idea of introducing a Tobin tax — a levy on financial transactions — named after the economist who in the 1970s proposed taxing cross-border currency transactions. However, this would not distinguish between “useful” and “useless” transactions. It is also hard to imagine a global tax that could not be avoided somehow.

Turner is right to launch a debate. His comments will also help counter accusations that financial regulators have been captured by the industry they are supposed to police. But the reforms he has proposed cannot be imposed unilaterally by any one country — let alone by a regulator that may not exist in its current form a year from now. Shrinking the financial sector will require a global agreement every bit as robust as the intellectual consensus that allowed it to swell up in the first place.

8 comments

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Dear Mr.Peter,
Your article on Turner!s comments on markets especially from banks and similar financial institutions are worth.
What he said is true to some extents.
As per latest indications,many major western countries and from North American countries,economic revival are giving some encouraging results.
World recession is slowly erasing from our minds.
Now,this is a time for private investors,industralists,and stock market experts,depositors can raise their collars for better returns and for better per capita income,jobs generation,reasonable production,sincere labor participations for their personal welfare as well as contributor to national wealth.
Still,many affected nations can learn from China,India,Brazil and Russia for halting any future damages,panic in real estate and in stock markets.
Now,the word!swallow! will be erased in financial markets.

“swollen beyond its socially useful size” – sounds to me more like a very apt criticism of our government than of the financial sector, and I’m not a banker.

Posted by Matthew | Report as abusive

Bank funding based on cheap money from the government and put to work at anything from 8 to 18% to citizens of the government; and not to mention zero dividend for investors, it’s about time reality came to dawn.

Posted by Jitendra | Report as abusive

Re points on the Tobin tax: it’s not a question of whether it can be done, it’s about political will. If you look at the success the US has had in restricting some countries banking activities (Iran for example), or how SWIFT is central to all transnational banking transactions, then you start to see how it could be applied.
Anyway, it’s not about exempting “useful” transactions and taxing “useless” ones, it’s about taxing ALL large international transactions. Something like a basis points for transactions above a certain amount. The idea is that if you’re investing abroad to build a factory, it’ll be irrelevant. However, if your game is to collect a few basis points from moving large sums, then you might think twice. That ought to reduce “hot” speculative money and make clever arbitrages less profitable. And the underlying discussion we ought to have is to question the consensus of the last 20/30yrs which is to say taxing income is ok, while taxing capital is not. (let capital free, it’ll bring growth, tax income, cause it’s easy!) i don’t have the answer, but I think all options should be on the table, not just hike up income tax rates.

Of course, it’s a long shot, but instead of dismissing the idea out of hand as impractical or infeasible, we ought to give it careful thoughts and debate its avantages and inconvenients.

Posted by fxtrader | Report as abusive

Totaly agree however we have the big problem of the reversed “Survival of the Fittest” or the “Peter Principle” described by John Kay in The Financial Times August,25. The capable bankers get killed of and didn’t recieve any bail out while the incapable get extra bonusses from a huge bailout on taxpayers account. A very destructive system which will recon itself in the near future. We live in Alice in Wonderland where the Koelee drinkers get rewarded and the good banks get the guillotine!?

Posted by Youri Carma | Report as abusive

A column at VOXEU based on a recent IMF working paper proposes a Pigovian tax on banks to reduce their incentive to take excessive risks. It also lists several recent FDIC measures that effectively did just that.
http://www.voxeu.org/index.php?q=node/39 01

Posted by commonwealth | Report as abusive

The Govenment themselves have created a massive issue with the merger of Lloyds HBoS. And herein lies the problem – govenment interference. Banks must offer accounts to those who are socially and financially excluded and these are expensive to run, expensive to maintain and are often the most time consuming customers. Since benefits had to be paid into a bank account, this has become significantly worse – 60m people need a bank account in the UK.

Then we need to consider the British public, who demand lending at low rates, savings at high rates, a free current account that pays interest, a low-rate credit card, 24 hour internet and telephone access, ATM’s available everywhere AND a branch network to support it all. With social mobility being what it is, you need to have a substantial amount of offices around the country to ensure you can offer the services your customers require. If you don’t, someone else will take them away. Economies of scale dictate that bigger banks can provide more extensive services.

It’s not just in the UK either, people increasingly expect international mobility. Could a Dagenham & District Bank or a Durham Personal Finance Bank offer that? Not a chance.

Finally, if we start taxing the bigger banks more, it will back-fire spectacularly. International Banks will shift head office, move to less rigourously regulated countries, go where the money is. The FSA is flexing it’s muscles because it was naive enough to let the current crisis happen. It sat back and watched things it didn’t understand, applauding the profits and expansions, not even mentioning big bonuses or higher tax. The FSA is desperately trying to show it has a place in the new world and that it actually has a clue. It doesn’t, on either point.

Posted by Adam K | Report as abusive

It seems to me that Turner is laying a foundation for the future – you start a new role and immediately threaten and cajole those around you. In this case, a new boss for a failed regulator making threats that can be quickly and easily watered down when he gets down to business. He is also trying to make himself and his quango indispensible in an attempt to prevent the Tories diluting the FSA’s role.
Although the banks actions of late have been catastrophic for all of us, we must remember that financial services in general and banking in particular pay, via taxation, the bulk of the nation’s bills. A national tax on transactions will quickly mean that those same transactions and those that drive the transactions will conduct them from another, more favourable location.
Any dreams of this being an international tax are ridiculous. Can you imagine China, fast becoming the home of the world’s largest banks, imposing such a tax? Or the Middle East? It’s not going to happen. However, they would like it to happen hear, because they, not the British public, would be the primary benefactors.

Posted by Frank W Meaden | Report as abusive