Jeremy Warner: Banking on the self-evident

Outlook Sir Andrew Large, a former deputy governor of the Bank of England, has this week been making the case for an over-arching authority to ensure financial stability, and he makes it well. Yet who does he propose to be the keeper of this new position but the Bank of England, which has always been responsible for financial stability and is in any case in the process of having its stability functions strengthened.

The problem at the heart of the present crisis is not there was no one responsible for financial stability, but that the authority which was responsible for it, the Bank of England, was insufficiently alert to the dangers of the build-up in credit and did nothing about it. Equally damning, the Bank was slow to recognise the significance of the credit squeeze when if began, and then rather than treating the sickness early with adequate injections of funding into the banking system, let itself become side-tracked by academic concerns over moral hazard and the need to let markets take their course.

Sir Andrew may have a point when he complains of inadequate powers, yet it is easy to design a system of perfect oversight after the event, but much more difficult to spot problems in the making and even more difficult when the party is in full swing to justify interference in developments and trends of uncertain outcome.

Sir Andrew should know this better than any, as up until early 2006 he was the deputy governor of the Bank of England in charge of financial stability and was not notably vocal while in the job in warning of the dangers of the credit bubble or the build-up of leverage in the banking system.

The fault with the Bank's financial stability function was that after direct supervision of the banking sector was outsourced to the Financial Services Authority, it became a forgotten backwater of what the Bank did. Instead, the Bank's entire focus became that of controlling inflation, with little thought given until it was too late to the threat that might be posed to macro-economic stability by the antics of the banking system.

The Government proposes to deal with these shortcomings by making the Bank's responsibility for maintaining financial stability a legal obligation backed by the establishment of a "Financial Stability Committee" to act as an early warning system. Sir Andrew seems to want to go further to give the Bank an explicit mandate to oversee the build-up of leverage and where necessary stop it in its tracks.

Yet this too is hardly a new idea, with an already intense debate over the merits of various forms of counter-cyclical capital regulation, so that banks would be forced to increase their capital and liquidity in the good times, but would be allowed to run higher levels of leverage for less capital in the bad. Sir Andrew should stick to the day job, whatever that may now be.

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