Gravesham and Dartford Liberal Democrats

Regulation and Growth

We are now confident enough to say that things are getting better even if the effects of the crisis, particularly on employment, are not yet over.

It will also take a long time before public finances recover. Commissioner Almunia has called on Member States to tighten their belts by up to 2 percent. It will be the public that bear the brunt of this and as a result governments will lose favour; politicians will lose seats. Neither public nor politicians will escape or forget the causes of this crisis for some time.

So although the financial world, banks in particular, can be regarded as a patient - undergoing treatment but still in intensive care - you will have to face the regulatory music in the end.

I like the 'illness' analogy because it can be used to cover a lot more of what we are doing. The financial sector has had a serious illness and we have treated the symptoms. But we are still struggling to find the inoculation that stops it happening again.

The medicine that we have used, and which is being prescribed in future doses, is higher capital. This is the instinctive response to any crisis but it brings with it problems, especially with SMEs, that credit is harder to get and interest margins have to be higher.

Margins are higher for a variety of reasons, three obvious ones are:

Risk had been priced too cheaply and now an adjustment is being made.

Banks are being asked to find more capital right now and warned of more capital requirements in future - so they have no option but to start provisioning.

Extreme risk aversion which is being suffered by regulators also affects banks in their assessments of businesses seeking loans, so the adjustment on risk has probably swung too far.

Therefore even without pricing in other regulatory costs there is a serious impact upon growth by virtue of a continuing squeeze on business and consumers. If we were in a healthy state - the good times so often referred to when dynamic provisioning is talked about - this would not present a problem. But we are not in the good times so a combined regulatory response that costs maybe half a percent or more off growth is medicine with side effects.

To minimise side effects it is very important to remove uncertainty. Was the higher capital announced by G20 finance ministers the same higher capital already announced previously or more? Does implemented by the end of 2012 mean the start of a transition to more capital or the end? Is this all included in Basle or something more?

The sensible interpretation is that it will all be in Basle and appropriately phased - but I understand that those running banks and businesses have to consider and prepare for worst case scenarios. That is the mood of the moment and what was not done before.

But at this stage my mind turns again to the Stability and Growth pact - as I said, returning into the frame now we hope we are on the way out of crisis and recession.

The tightening of belts sought by Commissioner Almunia is stability.

But the other side of this is growth. The name says it all. Whether intentional or otherwise there will always be two sides, not always pulling together, and we need balance. Stability and growth.

But it is not just on the macroeconomic side that we need balance. Right now we have a swathe of regulation that aims to give stability in financial markets. But at a time when we are struggling to return to growth we must look at the consequences.

I am not against tightening of standards. I suspect that in some quarters there is protest against change for the wrong reasons. But I am very concerned about the lack of an overall impact assessment on growth.

So it is about time we had a regulatory stability and growth pact to accompany the ad hoc FSAP 2 or financial stability action plan that we find ourselves in. This regulatory stability and growth pact applies not just to the making of new laws, but also to their implementation and application by supervisors.

No matter how high we set capital requirements they would not have stopped this crisis, nor mend the problem of liquidity, nor ever provide the EU average of 31% of GDP that has been guaranteed to prop up our banks.

However we do need to make changes in areas where controls and governance were bad - large exposures and trading book are two of them and they are the more valid because they were flagged before the crisis. So Basle should continue its work. But there are dangers for us in a piecemeal implementation, especially if it disregards other things that are going on.

For example AIFM, which could increase premiums for pensions and insurance by some 10% and we are expecting higher capital charges and overheads on derivatives. These costs will inevitably work their way through to the real economy and it is our duty to minimise that impact.

This leads me to the supervisory architecture. If I continue the medical terminology maybe this is the vaccine that we hope can inoculate against future crises.

It has been brought forward as a response to the crisis, at least as far as the Commission and Council are concerned. The Parliament has raised this issue three times - in the Garcia-Margallo report in 2000, the Van de Burgh Report in 2002 and most recently in the Van de Burg/Daianu Report in 2008. So we have done a lot of thinking before the recent proposals. That similar solutions are not just the result of the crisis adds validity. However, that the Parliament saw the solutions first then gets left out of any significant role for the control or governance has been noted by us, and do not be surprised if we change that.

Since I am constantly being asked where the Parliament is at, I will tell you.

The first exchange of views will be in Strasbourg on Monday 23 November. As I have promised, I am doing everything I can such as timetabling extra committee meetings during plenary weeks to do our work as quickly as possible. But we insist on doing a thorough job, so there will be no undermining omissions or short cuts. And we are robbed of time also for appointing a new Commission. Realistically this means completion of the package by the summer rather than earlier.

It is too soon to say what our conclusions will be but there seems rather too much concentration on national issues rather than cross-border situations. I certainly would like to see much stronger coordination and inter-disciplinary and cross-sectoral interaction.

There is the eternal agency problem of who monitors the monitor? And with more powerful European agencies, removed from the intensity of overview that happens more easily at a national level, how would the concept of my regulatory stability and growth pact apply?

Without doubt one of the problems we experienced causing the crisis was that everyone thought the same - regulatory, supervisory and academic capture. What is there to stop that recurring?

In the field of statistics we have introduced a Governance Board that looks at peer reviews and use of statistics. It almost certainly suffers from not being strong enough, but it is a start.

We have not started to address this problem in the supervisory architecture. Peer review, supervisory boards and so forth do not introduce an adequate external element of independent expert thought. Still less if there is no public accountability.

Looking over to the European Systemic Risk Board, this has become an internationally fashionable concept, which is good, and clearly it can have a role linking up with other macro-economic boards such as the US Stability Council (or whatever it is called eventually) and the international FSB. But it does not have everything covered. Is this the forum that should understand cross-sectoral problems?

Recently when in the US I raised with the Federal Reserve the scenario in which it could find itself regulating a European Insurance Company active in the US which was considered systemically relevant. I asked how good they were at insurance regulation. The answer was not at all and they had not really thought about it. My response was to urge that they did create a Federal level insurance supervisor - this would be most helpful in trying to find equivalence within the framework of Solvency II - and maybe it could provide the insurance know how for systemic oversight in the scenario concerned.

But whilst doing this I have to admit I felt a little fraudulent in that our European Systemic Risk Board will be a little light on experience, and even lighter on voting power, from non-bank regulators. One thing this crisis has surely shown is that macro and micro supervision are intimately entwined.

The proposals are a good start, it is clear that more work needs to be done, and it is probably the case that we can not solve all the problems I raise, and others, immediately. But we do have to make sure that we have not excluded the possibility of solving them in future an evolutionary process.