Banking on Recovery: The role of regulation

Warwick Lightfoot

Friday 26th July 2013: This week, in Politeia’s new volume The Financial Sector and the UK Economy: The Danger of Over-Regulation, a number of the country’s most distinguished economists warned Ministers that the emphasis, volume and efficacy of regulation for the financial sector may not bring about the intended results. Indeed it may prove counter effective. This week the Business Secretary the Rt Hon Vince Cable MP criticised the Bank of England for holding back the recovery by imposing excessive financial burdens on the banks. Is he correct?

Here, Warwick Lightfoot, a former treasury economist, explains that Ministers and the Bank of England have still not fully grasped the current condition of the UK banking sector and need to look beyond capital requirements when seeking remedies.

Since the credit crunch in 2007 and the collapse of the banks in 2008 the emphasis of British policy makers has been on improving the framework of regulation and increasing the capital base of the banks to ensure that it cannot happen again.

Instead what was required was an intrusive assessment of bank asset and liabilities and a willingness to recognise that much of the UK banking system was insolvent. The Federal Reserve has been much more assertive and more willing to take toxic assets off bank balance sheets. As a result the US credit system that is beginning to function again.

However, in the UK ministers appear to have deferred to a central bank that has been slow to grip the continuing awkward condition of UK bank balance sheets. Policy makers have accommodated a banking industry that exhibits zombification, similar to that of the Japanese banking system in the 1990s. The matters at issue are much bigger than the capital base required by banks, but it is good that a senior minister is now prepared to set aside deference to a central bank that has been shown to be too timid in its actions since the start of the crises in July 2007.

*Warwick Lightfoot is a monetary economist who served as Special Adviser to the Chancellor of the Exchequer 1989-92. He is author of Sorry We Have No Money: Britain’s Economic Problem (2010).

The Financial Sector and the UK Economy: The Danger of Over-Regulation was published by Politeia on 23rd July 2013.