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Mervyn King’s testimony highlights challenges for regulators

Finance Blogger: Anthony Harrington Anthony Harrington

The recently elected Treasury Select Committee were left with much to ponder after hearing testimony from the Governor of the Bank of England Mervyn King [PDF, 39 KB] on July 28. The meeting had been put back till Wednesday that week to give King the chance to return from his tête-à-tête with other central bank governors and heads of supervision over the provisions of Basel III. While several of the proposed provisions of Basel III have taken some stick, King’s chief concern in relation to the proposed new regulatory framework is that it probably won’t be tough enough! However, his stance on this sounds a bit paradoxical. He wants tough measures, but not yet, not till the banks are healthy again. As he puts it: “… bank balance sheets are still recovering from the current crisis … we need banks to be able to expand their lending in order to support the wider economy before they are required to meet the new standards.”

Of course, this makes eminent sense when one recalls that Basel III is about preventing the kind of exuberant reckless trading which underestimated and underpriced risk and which led to the crash. The global economy is in a much more depressed state right now and there is not exactly a pressing need to restrain exuberance!

Given this, King and the other central bankers are braced for a prolonged introductory period for the new standard, once it becomes ratified, given the weakness of the world’s financial systems. The thing that appears to be really worrying the Governor of the Bank of England is that the deep underlying causes of the crash, namely global trade imbalances, are still very much with us. As he puts it:

“Those imbalances are likely to be larger this year than last, and will probably still be around three-quarters of their level at the peak immediately prior to the crisis. Until these underlying problems are resolved, uncertainty about the outlook for the world economy will remain.”

What can mere politicians do in the face of global imbalances? Harangue the Chinese? That has been done with conspicuously little success, and by more senior global politicians than the Treasury Select Committee, no disrespect intended.

King’s testimony knocked a five week run up of the pound against the dollar on the head by re-emphasising the need for the Bank of England “to keep our foot firmly on the monetary accelerator”. Putting the world on notice of more quantitative easing does not help a currency’s relative value, however much it might shore up a sinking economy in the short term. Again this is a touch paradoxical, since if the expectation was that quantitative easing would really bounce the economy onwards and upwards, that should, in theory at least, make people feel more warmly towards Sterling. However, the world tends to take the fact that you are pumping air into your money as the established fact and is minded to offer little credit to the hoped for positive effects on the economy until they are real enough to trip over.

The Times ran an article by Sam Fleming and Gráinne Gilmore which picked up on what it regarded as the Governor of the Bank of England’s “moral indignation” at UK banks failing to live up to the spirit of long standing relationships with medium and smaller business clients by changing their lending terms unfavourably through the impersonal mechanism of computer generated letters. The Governor’s deeper concern was that the current “credit drought” would stifle the nascent recovery.

Further reading on the coming wave of bank regulation and on quantitative easing

Tags: banking , Basel III , global imbalances , Mervyn King , regulation , Treasury Select Committee
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