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King urges fundamental banking reform
October 20, 2009
By Christina Fincher
London - A fundamental rethink of how the banking sector is structured and regulated is needed to prevent a recurrence of the financial crisis, Bank of England Governor Mervyn King said on Tuesday.
Speaking in Edinburgh, home of credit crunch casualties RBS and HBOS, King said there was a strong case for not allowing banks to become so large they cannot not be allowed to fail.
King said the use of taxpayers' money to prop up banks had created "possibly the biggest moral hazard in history" since institutions had an incentive to take risks if they were confident they would be bailed out.
"It is hard to see how the existence of institutions that are 'too important to fail' is consistent with their being in the private sector," King said.
"Encouraging banks to take risks that result in large dividend and remuneration payouts when things go well, and losses for taxpayers when they don't, distorts the allocation of resources."
King argued regulators needed to design additional policy tools to moderate the growth of the financial sector and lean against the impact of the credit cycle on the wider economy.
"Parallel to the long-established role which monetary policy plays in taking away the punch bowl just as the party gets going, so there is a role for the central bank to use macro-prudential policy instruments for financial stability purposes by turning down the music just as the dancing gets a little too wild," King said.
The view that banks can be "too big" puts Britain's central bank governor at odds with the Financial Services Authority, the country's top regulator, which has so far focused its efforts on rebuilding banks' capital and liquidity buffers.
Britain's opposition Conservative Party, which polls say is favourite to win the next election due by June 2010, has pledged to abolish the Financial Services Authority and hand its supervisory duties to the central bank.
King argued that tougher capital requirements could mitigate the likelihood of bank failure but did not eliminate fully the need for taxpayers to provide catastrophe insurance.
A better way to tackle the problem, he suggested, might be to separate utility aspects of banking - payments and basic saving and lending - from riskier speculative activities, something already advocated by former Federal Reserve Chairman Paul Volcker in his report to the G30 think-tank.
"In other industries we separate those functions that are utility in nature, and are regulated, from those that can safely be left to the discipline of the market," King said.
King said it was in the public interest to reduce the dependence of millions of households and businesses on a small number of banks.
"If unsustainable capital flows provided the fuel and an inadequately designed regulatory system ignited the fuel, the past two years have shown how dangerous it is to let bankers play with fire," King concluded. - Reuters
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