UK’s FSA changes rules of regulation
UK’s Financial Services Authority, the role model for regulation has flipped its stance…
Lord Turner’s report sums up the shift as follows:
· Until the crisis struck, the FSA’s approach was based on an overt philosophy that markets are in general self correcting, that market discipline is effective, and that management and boards are better placed than any regulator to identify business system risks, provided processes, structures, and systems are appropriately defined.
· Therefore we focused on processes, structures and systems. We focused on individual institutions not sector wide or system-wide risks. And we focused on the probity of approved persons not their technical competence.
· And we tended to focus on conduct of business issues, and not enough on core prudential risks.
We are now 2/3 way through a programme which is changing that, not marginally but radically, moving to a philosophy of “intense supervision” which will entail:
· Much larger resources devoted to the supervision of high impact firms.
· A much more intense focus on business strategies and system-wide risks.
· More focus on technical competence not just probity.
· More focus on the details of bank accounting.
· And much greater willingness to reach judgments about the overall risks that firms are running.
This paradigm shift has caused waves in the world of finance and Martin Wolf writes in the FT
The most important analytical points are that individual rationality does not ensure collective rationality, that individual behaviour is frequently less than rational and that, in consequence, markets can overshoot, in both directions. Above all, such failings create systemic risks: if everybody believes in the same (faulty) risk models, the system will become far more dangerous than any individual player appreciates; and if everybody relies on their ability to get out of the door before anybody else, many will die in the inferno..
… this report is a milestone. It should help catalyse the needed global discussion of regulatory reform. Other countries – and, above all, the US – should commission comparable analyses of their own regulatory failures. I would also wish to see equally searching analysis of mistakes in monetary policy, both in the UK and elsewhere.
Humans learn far more from failure than success. The failures this time are big enough to make learning the lessons essential. The Turner report is a start. More learning must follow.
But what does this mean for India? TCA, writes on how the RBI’s much criticised stand has been vindicated and has another piece calling for answers from those who pushed the Rajan and Mistry reports in India:
In the end, we are left with several questions, only some of which can be asked openly. One of them is addressed to Indian economists: Why is it that if India has an approach to something, Indian economists wait for it to be validated by the West before they accept it? Indeed, why do they attack the Indians who advocate that view before such validation is bestowed by the West? I genuinely believe that the Finance Ministry, which funded the Mistry report, and the Planning Commission, which funded the Raghuram Rajan report, have some serious explaining to do. As indeed do the economists who toed their line and kept up LeT like attacks on the RBI.
When will people realise that in the debate of markets versus the government, you shouldn’t take strong stands either way - governments fail, markets fail - for the simple reason that both are made up of humans and human beings we know are not infalliable. This may not be ideologically satisfying, but it is the reality.
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Tags: financial regulation