A group of influential academics - including Professor Charles Goodhart of the MPC - will later this month publish a wide-ranging review of financial services regulation, including a thorough critique of the Government's proposed amalgamation of the nine existing City regulators.
Financial Regulation, why, how and where now?, which is published in association with the Bank of England, is set to cause ripples in the City. The book warns that single financial regulators, such as the new Financial Services Authority (FSA), might trigger cultural conflicts, wield excessive power and become over-bureaucratic.
It argues that official regulation should take a back seat to self-regulation by City firms and stresses that City regulators should be publicly accountable.
The book also suggests the public's excessive expectations of regulators run the risk of creating "an unacceptable extent of intrusion, distortion and cost".
In a foreword to the book, Eddie George, Governor of the Bank of England, calls its publication "opportune ... at a time when the future conduct of financial regulation and supervision is in a state of change". Mr George adds that the book "should help inform and guide the continuing debate".
In an interview with The Independent, Professor Goodhart said one of the publication's key messages was that responsibility for risk control should be shifted back towards internal management and away from external regulators. He argued that the regulatory regime should seek to realign the incentives of the regulated firms. Appropriate internal risk management ought to be consistent with the goal of profit maximisation.
One way of achieving this could be for firms individually to agree a series of internal risk management targets with their regulators. Failure to meet these targets would automatically result in penalties.
Professor Goodhart stressed that different types of financial services required different types of regulation. In particular, he said, there was a strong case for regulating banks differently from other types of financial institutions.
He also argued for separating regulation of "wholesale" activities - transactions between two financial institutions - from that of "retail" activities - transactions between an individual and a financial institution.
The differing regulatory requirements of different financial institutions mean there could be a cultural clash within mega-regulators such as the FSA, the book argues.
Professor Goodhart explained: "There is a culture of worrying about Aunt Agatha's investments and there is another culture of worrying about systemic issues [such as banking crises]". There were concerns that a single regulator could become overly worried about "Aunt Agatha's" problems and "take its eye off the banking ball".
According to Professor Goodhart, "there is a great deal to be said" for an alternative approach outlined in the book which proposes a separate systemic regulator for banks. He also makes the case for public accountability of regulators.
"It is arguable there should be a body to whom Howard Davies [head of the FSA] and other key people in the FSA should, in a sense, report to". However, he said it was difficult to know who this body should be, as MPs could be "leak-prone" and regulators frequently needed to investigate highly confidential issues.
"Financial Regulation, why, how and where now?", by Charles Goodhart, Philipp Hartmann, David Llewellyn, Liliana Rojas-Surez and Steven Weisbrod, will be published by Routledge on May 21.Reuse content