By Tash Shifrin
Economists have warned that the public finances could be harmed by a further loss of tax revenue because of the ‘catch-all’ nature of Lord Turner’s review of financial services regulation.
Economists have warned that the public finances could be harmed by a further loss of tax revenue because of the ‘catch-all’ nature of Lord Turner’s review of financial services regulation.The Department for Communities and Local Government has also confirmed that it will consider the impact of Turner’s recommendations relating to credit ratings agencies on its official guidance on council investments.
Turner, the chair of the Financial Services Authority, blamed imbalances in the economy, financial innovations ‘of little social value’ and deficiencies in bank capital and liquidity regulations for the financial crisis.
This was ‘underpinned by an exaggerated faith in rational and self-correcting markets’, said his report, A regulatory response to the global banking crisis, published on March 18.
Turner urged a ‘macro-prudential’ analysis and approach to regulation – covering the whole system rather than individual financial institutions. ‘The failure to do this analysis and to take action on it was one of the crucial failures of the years running up to the crisis,’ the report said.
Prime Minister Gordon Brown attempted to forestall criticism of the regulatory system in a media interview earlier in the week, saying: ‘Perhaps ten years ago, after the Asian crisis when other countries thought these problems would go away, we should have been tougher.’
Turner called for fundamental changes to bank capital and liquidity rules and an increase in the capital held in banks, as well as changes to the role of the FSA. His report urged international measures to cope with the increasingly complex global system.
He said: ‘The changes recommended are profound, and the banking system of the future will be different from that of the last decade. The world’s economy will be better served as a result.’
But Ben Read, managing economist at the Centre for Economics and Business Research, told Public Finance that Turner’s report was a ‘catch-all, covering retail banks and financial services activity’ across the spectrum of financial institutions.
Its sweep took in the crisis-hit major banks that could not be allowed to fail, but also smaller institutions. These included investment banks and hedge funds, which had ‘performed well over the last 12 to 18 months’ and where a future collapse ‘wouldn’t matter to the economy’.
He warned: ‘We fear the catch-all regulation this review seems to be opening up. It is likely to harm the banking sector in the UK and some of the activities in the City of London.’
This would ‘lead to lower tax receipts’ from an important sector of the UK economy, further reducing the amount flowing into the Treasury’s coffers, he said.
Read said: ‘We’re not saying tougher regulation isn’t needed. But it needs to be focused on areas that the regulation is appropriate for – institutions that are absolutely crucial to the national economy.’
Turner’s report came a day ahead of public finance figures from the Office for National Statistics, which were expected to show continuing huge levels of public borrowing and debt, and falling tax income.
There was speculation this week that the government might postpone the Spending Review expected this summer because of the difficulties of setting out public spending plans from 2011 against the background of economic instability.
A further fiscal boost in the April Budget – predicted by some economists – would require even harsher measures than those set out in the Pre-Budget Report to return the public finances to balance after the recession.
Turner’s report also called for improved governance and regulation of credit rating agencies, to tackle conflicts of interest and ensure analytical independence – and urged that ‘inappropriate use of ratings’ should be reduced.
The agencies’ role and local authorities’ use of their ratings have been under the microscope since the Icelandic banking fiasco, after the agencies continued to rate the banks strongly until days before their collapse. Councils are still seeking to recover around £1bn from Iceland.
Turner’s report said the agencies were now increasingly emphasising that ratings ‘cannot be treated as carrying inferences for liquidity and price’. But it added: ‘Public policy should avoid unnecessary requirements for investing institutions to hold securities of a specific rating.’
Government guidance currently sets out which agencies should be used to rate creditworthiness. It says councils’ annual investment plans must specify how a ‘high’ credit rating should be defined and how rating changes should be monitored.
A DCLG spokeswoman told PF: ‘We need to consider the recommendations and will respond in due course.’
