Evolution not revolution in the City

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The Independent Online
REGULATION is about structure and about people. Both matter, but I suspect the former matters more. If the structure is wrong, brilliant people can hold things together for a while, but sooner of later things fall apart. If the people are wrong, they can at least do less damage if they are working in an appropriate structure, for their mistakes will become evident.

We have now had two seismic changes in the relationship between the Government and the City: the greater degree of independence given to the Bank of England over the formulation of monetary policy; and the co-ordination of financial market regulation under a reformulated Securities and Investments Board. It is true that both developments merely take further changes in monetary control and financial regulation that were in train. In that sense they are evolution, rather than revolution. But they take it a lot further and that is important.

To call this evolution rather than revolution may seem odd, given the balance of comment in the past few days. But if you look at the changes that are proposed, you can see the roots in past developments. For example, giving the control of interest rates to a Bank committee on the lines of the Federal Reserve's open market committee, takes the monthly meetings between the Bank and the Treasury one stage further. The meeting has the power to decide, not just to recommend, and the composition of the people round the table will be somewhat different. But the nature of the discussion will be the same and the key point of publishing the minutes of the meeting after a delay is retained.

Now look at the "super-SIB". When the SIB was formed it very nearly was made a statutory body: the legislation was all drawn up in statutory terms, but with a little clause that allowed the powers to be sub-contracted to a self-regulating agency. So we have had statutory powers administered by a private sector body. It was one of those convenient British fudges. At any rate, the change now merely removes an anomaly.

Now look at the handing over of banking regulation from the Bank of England to the SIB. Until the 1979 Bank of England Act the Bank had no formal role for supervising banks, save for those that it acquired for administering exchange control. Instead it relied on informal arm-twisting to control the City, while all the small fringe banks were administered by the DTI.

So while it may look as though the Bank is losing a large part of its empire it is only losing powers that it acquired recently and with some reluctance. It will still be able to twist arms. Further, it will have to retain some element of control (or at least influence) over banking, simply because it will remain lender at last resort to the banking system. For that reason, while banking supervision in both US and Germany is carried out by separate bodies, rather than the central bank, the central bank still in practice retains an overview of bank supervision.

And the other powers that the super-SIB will gain? There has been a clear need for co-ordination. As Gordon Brown pointed out there has been a blurring of lines between different sorts of financial institutions - building societies becoming banks, commercial banks offering insurance services and buying securities houses. It does not make sense for a single financial institution to be regulated by different bodies for different bits of its business. Regulation has to evolve too.

So these two big changes in the relationship between Government and the City are rational and orderly developments of existing trends. They are radical only in the sense that they are a big step forward; the step is in the same direction as past progress. No single structure of regulation, however well-tailored, will ever fit every eventuality. But the outline of the last two weeks looks promising, not because it is revolutionary but for exactly the opposite reason: it carries forward what we have already got.

So what can go wrong? There are two areas of danger, one relating to structure, the other to people.

There are structural dangers for both the Bank and the SIB in their new roles. The outline may be fine, but we do not yet know the detail. For the Bank, there are a couple of obvious potential difficulties. One is that it may lose influence in its role of promoting the financial services industry. It rarely gets credit for the way it has fostered the growth of the great job machine of financial services, but much of the success of London in holding onto market share in international business (actually probably increasing it) is down to the Bank. It helped crucially in establishing the eurodollar market, the founding of LIFFE, and of course the Big Bang reforms.

A second danger would be if the role of lender at last resort was weakened by the shift of bank regulation. It need not be; but the detailed definition of the frontier between the Bank and the SIB needs to be carefully managed.

The dangers for the SIB parallel these. Regulation ought to be a business asset, enabling customers to buy with confidence and producers to operate on a level playing field. Financial services are a mobile global industry and it ought to be possible for the UK to secure a comparative advantage, as it has to some extent in the past. That certainly ought to be the aim of the SIB: to be a lighter but more effective regulator than other comparable bodies round the world.

But regulation, however good, will fail from time to time. The danger is that people will have unrealistic expectations of what the SIB can achieve. If you look at the scale of taxpayer support for the financial services industry in the UK and compare that with France, the US or Japan, it is tiny. Yet there is a perception of under-performance. The SIB needs to combat that. Further, the SIB needs to feel its way towards the right balance in a whole series of relationships: with the Bank of course, but also with its "customers" in the industry and its constituency in government. This will not be easy for the new team, anymore than it was for the present one.

Finally there are the people. The new structure, in as far as we can see its outline, looks promising; but the transition could be scuppered by poor appointments. There are a series of things we can look for in the coming months to see if the transition is likely to stay on track.

The most obvious will be the appointment of the next Governor. There is a powerful case for asking Eddie George to stay on, partly because he is good at the job (not an insignificant matter) but equally because when you are changing structure it is sensible to maintain continuity by keeping people. One of the two new deputy governors should come from within the Bank staff. And the other members of the monetary panel need to carry respect for their judgement, rather than be seen as political appointees.

As for the SIB, well, it is very hard to think of anyone who would be more likely to do the job well than Howard Davies. This really does look very good: his mix of public and private sector experience arguably means that he will be better placed there than at the Bank. So that is really encouraging. Now the challenge is to build up a staff at the SIB that becomes an elite: not people who are career regulators, but rather people who see some regulating experience as part of a rounded career in the City. That is not easy; but it is very well worth doing; and it takes time.