Adair Turner, Chairman, FSA, gave a speech at the Mansion House City Banquet on 22 September 2009.

The theme of Lord Turner's speech was that following the worst financial crisis for 70 years, and the narrow avoidance of what could have become the new Great Depression, not only is radical change needed in regulatory and supervisory frameworks, but there also needs to be a change in the philosophy of regulation.

Further, parts of the financial services industry must recommit to a focus on their essential economic and social functions - particularly if they are to regain public trust. Lord Turner used the expression “socially useful” several times during his speech.

He went on to say that while the City is a huge centre of skills and innovation in a wide variety of activities, many extremely important in generating liquidity in key markets, and many not creating undue risks to the economy, it has to be recognised that not all activity and innovation is valuable or useful and a bigger financial system is not necessarily a better one.

Lord Turner made no apology for his remarks in his recent article in Prospect magazine in which he referred to the City’s ability to create unecessary demand for its own services and that some of its activities were “socially useless”. In response to the argument that in rich societies there will always be people who buy things they do not need, and therefore it is impossible to make objective judgements on the social usefulness of various kinds of economic activity, he differentiated between consumer products as end products, and financial services as intermediate ones.

The change in philosophy referred to earlier will need to be accompanied by a change in the FSA’s mindset. Prior to the financial crisis, the FSA and other securities and prudential regulators had automatically assumed that any financial innovation was beneficial, and that more trading and more creation of liquidity was always useful. The effect of this widely shared mindset was the setting of too low capital requirements.

So the mindset will change in three particular areas:

  • With the new International Financial Stability Board taking the lead, regulators world-wide will be requiring an elevated level of prudence from the banks in the form of larger shock-absorbing buffers of capital and liquidity.
  • Much higher capital requirements will be imposed against the more risky and complex trading activities, especially when their benefits to the economy are unclear.
  • Regulation will become more assertive, with less trust being placed in market discipline.

In short, regulators will have to dispense with the idea of perfect, self-equilibrating markets and rational human behaviour. And on the other side of the fence, as it were, bankers will have to change their behaviour as well, in order to regain public trust, by demonstrating that what they do is not only socially useful, but provides vital public functions which include linking savers to investments and allocating capital to efficient use.

Banks will have to concentrate more on their core functions, and although there will still be a need for activities the social usefulness of which will not be immediately apparent to the public and which will have the capacity to generate large rewards for individual traders, the banks will have to start thinking very carefully as to which of these activities actually do deliver, say, useful hedging value and which are in reality no more than speculative and risky exposures.

Lord Turner then moved on to bonuses, a key factor in the public’s trust of banks. He said that the role of bonuses in the development of the financial crisis should not be over-stated, and emphasised that the regulator’s role would be more likely to affect remuneration structures rather than remuneration levels.

The public’s concern, however, lies very firmly on remuneration levels. This is partly because they see banks rescued by injections of public money making large profits, and distributing correspondingly large bonuses, benefitting from the absence of those organisations which were not bailed out. It is also because it is a matter of legitimate public concern that higher capital requirements, which would tend to reduce profits and bonuses, are imposed on banks to avoid another financial crisis.

Lord Turner went on to say that the Financial Stability Board will state in its report this week to the G20 leaders that the priority use of high profit will have to be the re-building of capital. Lord Turner ended his speech with a series of statements expres

sed as hopes. He hoped that:

  • The banking industry will embrace the globally agreed priority to re-build capital.
  • The banking industry will understand why society expects it to think carefully about its economic and societal responsibilities.
  • The City will remain a vibrant and major force in the UK economy.