Strategic Finance
FSA: Tougher rules for bank trading |
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| Strategic Finance | |
| Written by Catherine Murray | |
| Thursday, 26 August 2010 | |
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UK markets watchdog recommends ending the regulatory divide line between a bank's trading and core books. The The Financial Services Authority (FSA) has released a 126 page discussion paper, recommending that ending the regulatory dividing line between a bank's trading and core books would price risk better and help avoid more public bailouts sparked by the financial crisis. The discussion paper considers fundamental changes to the regulation of trading activities. This was one of the key recommendations of the Turner Review following material trading losses incurred during the credit crisis. The Basel Committee on Banking Supervision (BCBS) has proposed several reforms to the prudential regime for banks, since the Turner Review was published, and in addition has mandated a fundamental review of trading activities called for in the review. The FSA believes that the delivery of a new, robust, long-term, approach to prudential requirements for trading activities is one of the key areas of regulatory reform that must be delivered to build a stronger financial system. The outcome of the BCBS’s fundamental review is central to achieving this objective internationally, the FSA said. The paper describes the FSA’s current views and ideas in relation to major areas of reform that need to be considered to address areas of structural weakness that exacerbated the build up of risk before the financial crisis. The FSA sets out a number of recommendations which are grouped into three key areas: 1. Valuation: "We recommend an increased regulatory focus on the valuation of traded positions and think there is a need for a specific assessment of valuation uncertainty." 2. Coverage, coherence and the capital framework: "We recommend changing the structure of the capital framework to bring greater coherence and reduce the opportunities for structural arbitrage within the banking sector and the wider financial system." 3. Risk management and modelling: "We recommend specific measures aimed at improving firms’ risk management and modelling standards, and ensuring that these are aligned with regulatory objectives." Paul Sharma, FSA director of prudential policy, commented, "There are clear benefits of participants in traded financial markets taking risks to facilitate a more efficient allocation of resources across the economy – where these gains in efficiency are real and the risks posed are adequately captured or controlled we are not seeking to undermine these activities." "However, the financial crisis has highlighted that, for trading activities in particular, an over-reliance on the principles of efficient financial markets can lead to severe consequences when risks are misunderstood at a system-wide level," he continued. "The balance needs to be redressed to ensure that risks posed to the system as a whole are more adequately reflected in the structure of prudential regulation," said Sharma. Jonathan Russell, vice-president of the accountant membership association UK200Group, commented on the FSA's report, saying, "Separating core banking activities from their ‘trading/dealing’ operations would potentially reduce the risk to the core banking system; it would however mean that the core banking sector would not benefit from the sometimes huge rewards generated from this trading area." Russell warned that if the core banking services were to be separated, it would "almost certainly lead to an increase in the price to the consumer as banks try to improve the margin they make on clearing activities". "The underlying problem is still that the banks’ balance sheets are not as good as they should be and certainly nowhere near as good as they would expect of a business customer," he said. "The credit crunch really was the banking industry realising that they had got it wrong and they are now busily trying to realign the balance sheets and matching short-term lending with short-term borrowings. This is why the mortgage market is under such pressure as banks do not have access to sufficient long-term money to lend to customers on a long-term basis," said Russell. Some accounting firms were averse to the FSA's recommendations. David Ingall, partner at JWPCreers commented, "I can see the risk-averse FSA version of their brave new world as being a nightmare. It will hit lending and if a transaction does not tick all the boxes it will not be done. Thus, there will be no development, little lending and it will be a commercial nightmare." "The old saying that ‘banks will only lend you an umbrella when it’s not raining’ will become real. Regulators should regulate, not try to create a new world in their image," he said. |
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