On the 27th September 2009 I made a speech to the English Democrats AGM and autumn conference entitled “  The ABC of Banking Regulation” (http://bit.ly/u2vCYM). I made the speech because as I said, “It [the bank crisis] happened because we had the lightest touch, and probably the most dysfunctional, bank regulatory scheme going”. The recent report on the Royal Bank of Scotland failure (the RBSR) by the Financial Services Authority, who were responsible for regulation, appears to agree with me.

Overall I am happy with the progress to date. Some of the matters I suggested have turned up as proposals or have been enacted. But we still face tough times and there will have to be a greater degree of  implementation of these ideas if we are to build a stable base for the future.

My A was accountability. I suggested that in order to achieve this we should have something akin to the Sarbanes-Oxley Act in the USA. The difference would be that bankers, the directors and senior managers, would go to prison for 5 years and suffer a £5,000,000 fine if their bank needed saving by the authorities. I still think that this is the one regulatory change that would ensure compliance with prudential banking practices. The RBSR is suggesting fines and exclusion from working in banks again for those who transgress. This is far from enough.

I had two Bs, both of which have been taken up by the coalition government. First was to put the Bank of England in charge of the regulation of banks and other depositary institutions. The second was based on a law in cybernetics called “Ashby’s Law of Requisite Variety”. Put simply this states that any regulator must have as wide a range of control measures available to it as there are ways of change in the system. The economic system is, and always will be, subject to wide gyrations that we call “boom and bust” caused by a variety of events. The regulatory authority must have a similar wide range of responses available and not just, as in the Bank’s case, the ability to raise or lower interest rates to control inflation. The coalition’s response to this suggestion has been the “Financial Policy Committee” which has wider powers of intervention.

I had three Cs; clarity, capital and compensation.

Clarity referred to stopping the ability of banks to create opaque, multilayered derivative product that are sold “over the counter” and thus in secret. The dangers are self-evident. The opaque nature of the the security makes it much more likely that that collapse will occur and the secret nature of the transaction means that banks do not know who holds this toxic junk and so will stop lending to other banks, the so-called “contagion” effect. The Frank-Dodds Act in the USA is in the process of moving these transactions to open exchanges where much greater clarity exists. The final report of the Independent Commission on Banking (The Vickers Report) has proposed the banning of dealing in derivatives by the ring-fenced commercial arms of banks whilst the investment banking arms going through a process to improve clarity, somewhat.

It became clear that banks relied too much on borrowing and not enough on their own capital as well as having a deficient method of risk calculation, which would in itself lead to too little capital. I was being far too optimistic. The RBSR infers that there may not have been any risk calculation on occasions.

The new rules under Basel III will increase capital levels and the UK wants to increase the levels of capital held by larger banks even more (the EU on the other hands wants to reduce the levels of capital proposed). It was clear that increasing the levels of capital would result in lower level of lending and liquidity in the banking system. This is very evident in eurozone banks, where the appalling level of management of the system, has meant European banks withdrawing cash from the international system where its effect will be felt not just in the EU but in developing countries as well as elsewhere in the world.

I suggested that some of the problems of increasing capital could be overcome by requiring (investment) banks to insure against sudden, but infrequent, requirements for increased capital. This could be done by a mixture of government and private sector insurers, provided that the premiums that go to the government are deposited in a ring-fenced fund to keep off the sticky fingers of politicians who, when it comes to giving goodies to voters using someone elses money, can show a degree of “stickiness” that far exceeds that of your average banker!

The third C is compensation. I suggested that commercial banks could be subject to a significant regulation including control of compensation. In return directors and senior managers would not be subject to custodial sentences if the banks needed saving. The RBSR suggestions concur with my mine on this matter.  The question of excessive compensation is still an issue and solutions are still being discussed. There is no sign yet of criminal penalties, a situation that needs to be speedily changed.

My D was for division. I felt then, and still feel, that investment banks and commercial banks must be split. The Vickers report is recommending a half-way house of strict firewalls. I hope this succeeds but fear it will not. We should remember that investment bank are by nature risk taking and piratical institutions. If they were not they would not be successful.  Whilst a group of greedy investment bankers have within their line of sight a pile of someone elses money sitting in deposits they will move heaven and earth to get their hands on it. The subterfuges they will employ will often not be discovered by the regulators who will end up being powerless to stop it. Only the strong threat of a prison sentence could have any hope of stopping this behaviour.

If we are to have a strong banking regulation system in a sea of lighter touch regulation it will be all too easy for the banks in the later environment to undercut UK regulated banks in their product and service pricing hence leading to a decline in English banking. To do this we need to take powers to tax companies, fairly, that have used foreign products that are cheaper due to easier regulation. This should not extend to taxing solely on the basis of cheapness, some of which is due to efficiencies. There is no sign of this yet. This was my F

My L was for government to stop being lead by the nose by bankers and to start leading themselves. This, at least in the UK, but not it would appear in the EU, is starting to happen.

The score to date is zero for A, two for B, two halves for C, a half for D, a zero for F and one point for L, a total of four and a half out of nine suggestions or 50%. We still have a long way to go. It will be interesting to see what emerges.