This snapshot taken on 07/04/2010, shows web content selected for preservation by The National Archives. External links, forms and search boxes may not work in archived websites.
Newsroom & speeches
15 October 2009
One year and two days ago the British Government provided £37 billion in new capital to the UK banking system.
Just days before, we had announced an unprecedented guarantee of interbank lending and a massive expansion of liquidity support.
Within weeks these moves were duplicated by governments around the world.
Faced with the instability brought on by worsening global credit conditions and exacerbated by the collapse of Lehman Brothers, taxpayers across the globe found themselves acting as the lifeblood of international finance - and in many cases serving as the unhappy new owners of some our most troubled financial institutions.
Today, though, it is the future, not the past, that I want to talk about – specifically, the future of our regulatory architecture.
But one year and two days on from our intervention in the markets, I do need to remind people where we stood not that long ago.
What we learned last year was that when the pressure was on, the system could not stand on its own two feet - it needed the support of the taxpayer to survive.
In the process of saving the system, the relationship between the public and the banks has been fundamentally changed.
The public now demand of their Governments that we do everything in our power to stop their funds being called upon again in the future, in similar situations.
So while I am pleased to see improvements in the health of the sector compared to where it was a year or even six months ago, the need for change remains comprehensive.
And importantly, the need for change has been recognised on a global level.
In my comments today, I will summarise the progress we have made in recent months in building momentum for both global and domestic reform.
I believe strongly that the reforms taking place on the European level are of great importance to the UK financial system and they offer huge opportunities which we should welcome.
I intend to give an indication of the sort of issues all of us need to consider as the EU continues to debate changes to its regulatory architecture.
Reflecting on the crisis, we know now that some banks did not understand or manage the level of risk they were accepting.
Regulators and central banks did not sufficiently take account of the excessive risks being taken on by some firms and the failure of shareholder stewardship.
Global regulatory standards failed to respond to the challenges of system-wide risk.
This was compounded by the failure of the tools of market discipline.
It was immediate and co-ordinated responses by the UK, EU and G20 which protected our economies from worse consequences of the financial crisis.
We have taken extraordinary action in the UK to recapitalise our banks, to offer to insure banks from losses and to improve funding.
Across global boundaries, we have agreed on measures to stimulate our economies and have worked together to resolve cross-border issues.
It is crystal clear that the financial services system needs robust and effective regulation within countries, but this will never be enough.
The simple stance of “home” state regulation, based on some minimum standards without intrusion into how they’re applied, coupled with “passporting” rights, has been called into question by the failure of Icelandic banks, and the knock-on effects across Europe.
As the EU’s biggest “host” country, we have a bigger concern than anyone else in effective safeguards for cross-border business.
Regulation needs to be of a sufficient quality across Europe to protect investors and our economy.
We cannot allow regulatory arbitrage in which business gravitates towards the most lenient regime, only for the same businesses to operate in and place risk to financial economies of other countries.
I am pleased that there has already been much convergence in the positions of EU Governments on the issues raised in repairing global regulation.
We must build on this now to equip the system better to prevent and deal with future crises, as well as deliver the value added needed for growth and employment.
To date, the UK has played a strong role in co-ordinating the global response through its Chair of the G20 and through its participation in the FSF and now the FSB.
And the Turner Review and the Government White Paper Reforming Financial Markets have offered innovative ideas and strengthened the quality of global debate.
The UK has not been alone in this work. We want – and need – to take our partners with us.
We want the EU to take the mantle in leading the debate – and it is, thanks to the work of Jacques de Larosière.
Through reforms, we in Europe can enhance the single market and influence global regulation, reduce our financial stability risk and strengthen our economies.
I would like to propose four areas where the EU should concentrate to develop a better regulatory system.
Firstly, we need to develop standards for individual financial institutions that will apply across the Single Market and across the globe to provide confidence and stability.
We have to find agreement on how best to encourage or require banks to build up a buffer of capital during good economic times. Such a buffer works against the pro-cyclical tendency of markets, where risk-taking amplifies up- and downturns.
Banks should give priority to conserving and building up capital, to drive up confidence and allow banks to continue their operations. The need to rebuild capital is critical.
We need tighter definitions of core-capital; and future structures for hybrid capital and sub-debt must be indisputably capable of absorbing losses; protecting taxpayers from picking up the tab.
There is already an international consensus on addressing this issue, and the EU should, and will, lead the debate in turning this consensus into concerted action.
Secondly, we need to get the basic ‘plumbing’ of banking right.
The collapse of AIG highlighted the dangers of poor management of counterparty risk.
The absence of a central counterparty for CDS meant there was no firebreak to prevent contagion.
This could - and should - have been mitigated through bilateral collateralisation, but credit rating downgrade triggers actually exacerbated systemic risks, leading to AIG’s insolvency.
The UK is at the forefront of addressing counterparty risk in derivatives markets.
At the global level, we are leading work to strengthen bilateral collateralisation, to make it as equivalent to central counterparties as possible.
We have secured the agreement of global over-the-counter derivatives supervisors for a major overhaul of bilateral collateralisation and anticipate formal approval from industry next week.
We are working with partners to drive fundamental reforms in this, and other areas.
We need to ensure that all central counterparties in Europe are run to the same highest prudential and operational standards.
For 18 months, we have been calling for a European directive on central counterparties.
This would also ensure a genuine single market for central counterparty services – which, as we have seen, play a vital role in reducing financial contagion.
Agreeing standards and getting the infrastructure right will only take us so far – supervision needs teeth.
If we agree to legislation in the EU, we must implement and enforce it. The UK supports the establishment of the European Regulatory Authorities.
The ESA’s role in assisting the Commission to ensure compliance will be invaluable. The ESA role in peer review will improve trust and confidence in our supervisors and our supervisory archictecture.
This will produce a more common supervisory culture, reduce misunderstandings and lead to a greater convergence of supervisory practices.
We must enforce it globally.
On the back of commitments made by G20 Leaders in London in April, the Financial Stability Board will have a renewed mandate to develop and implement strong regulatory and supervisory policies, addressing vulnerabilities in the financial system.
Finally, we cannot insulate ourselves against financial crises. It is our duty as governments and regulators to do all we can to avoid them – through better regulation, better supervision and better mediation, as I have discussed.
Of course, early warning is critical. In the UK we are establishing a Council for Financial Stability, chaired by the Chancellor.
In Europe we will establish the Financial Stability Risk Board. Internationally, there will be closer collaboration between the International Monetary Fund and the Financial Stability Board.
But when crises do arise, we need to be on the front-foot. As Jacques has recently acknowledged, this is an area where further work is critical.
We believe that this needs to begin with financial institutions; in the UK, we are exploring “living wills”, contingency plans to facilitate the speedy wind-up of systemically significant institutions.
These plans are essentially blueprints for ensuring that the firm itself, or the firm and the authorities acting together, can respond and de-risk quickly and effectively if the firm get into difficulties.
They should plan for resolution and for wind-down, protecting customers, investors and importantly, the taxpayer.
I believe that this would be significantly more effective than burden-sharing agreements that are difficult to reach in advance, and even harder to implement in the midst of a crisis.
Living wills will permit controlled failure, with capital absorbing losses, as intended.
Contingency plans will oblige banks to understand the complexity of their group and, where necessary, to simplify their structures.
This will not be easy to implement - but we feel it is too important and we will not ignore the challenge of living wills.
If necessary, we will legislate this autumn to ensure that systematically significant institutions have credible plans for resolution.
There has, as I mentioned, already been agreement at G20 level about the necessity of systemic firms developing such plans.
It is vital that we follow through on this, and that Europe is able to lead the charge on adapting the legal framework to allow for such contingency plans.
These proposals are essential, and we will work with Europe to go further, faster.
But at all times, our approach needs to be proportionate.
We do not wish to kill financial services; I believe regulation can and should be consistent with long-term sustainable growth.
The UK has a critical role to play here. We bring with us expertise and experience – experience of both good and bad.
We should balance our desire to end uncertainty with our desire to allow markets to flourish and create value. We should promote very best practises in banking, and learn from best practise in regulation across the globe.
Not all risks can be addressed simply through regulatory reform.
The incumbent governance framework allowed priorities in some banks to be skewed in favour of the short-term interests of a select handful of employees, and away from the long-term interests of capital providers.
Corporate governance needs to improve, as does the culture surrounding financial institutions’ operational and risk management.
Investors and their agents need to take governance much more seriously; boards must be active, alert and engaged; shareholders and institutional investors need to think and act like owners. After the crisis, it is reasonable to ask ‘what were the owners doing’?
Governments can and must help.
In the UK, Sir David Walker is due to report on the governance landscape in the banking sector, and, in line with his interim report, will make recommendations for far-reaching changes to strengthen board challenge and shareholder oversight, and improve the quality and independence of risk management.
Again, this can’t just be at the national level – and across the globe we recognise that remuneration policies must never again contribute in the way they did to excessive and unmanaged risk.
Here in the UK, we have signed agreements with our biggest banks to implement the principles agreed at the G20 this year; they have committed to implementing important enhancements in disclosure, deferral, and clawback with effect from 1 January 2010 for performance year 2009.
Yesterday, I met with the UK subsidiaries and branches of leading overseas investment banks operating in London, and they have now agreed to support the implementation of reforms to bank pay agreed by the G20 in Pittsburgh. Again, this is in respect of 2009 performance.
I am pleased that the UK has been at the forefront of this move for change.
But this requires more action from all parts of the financial services ecology, and institutions, shareholders and investors must play their role.
The financial crisis has shown us how vital our financial services sector is, and how devastating its failure could be for our economy. Financial infrastructure is global in nature; and we can only be effective within a solid regulatory and supervisory framework agreed at a regional and global level.
By ensuring tougher, unified and proportionate standards for the single market, Europe can be at the forefront of regulatory progress, building on the considerable agreements already achieved by the G20.
We strongly welcome President Barroso’s commitment to “smart regulation” in his manifesto to the European Parliament, where he stressed the need to ensure that regulation is “effective, proportionate and comprehensive”. This will give the EU high quality rules and make it a global leader in regulation and supervision.
We have the opportunity to shape the new global framework, and it is vital that we grasp it with professionalism and enthusiasm.
