A multilateral assault on so-called "shadow banking" will be led by Lord Turner, chairman of the Financial Services Authority, when he publishes his much-awaited review of financial regulation on Wednesday.
The FSA is also expected to tackle the controversial subject of rewards for bankers and traders, the structure of which has been attacked by the Governor of the bank of England, Mervyn King, and many others for its tendency to encourage short-termism and excessive risk-taking. One option would be to require banks that defy the FSA's views to meet higher capital adequacy requirements, reflecting and offsetting the extra perceived risks that their staff might be running. The banks are already required to tell the authorities about their pay systems.
At the weekend's meeting of G20 finance ministers, the conference approved a paper entitled "Restoring Lending: A Framework for Financial Repair and Recovery". This called for "full and transparent disclosure" of toxic debts and banks' bad assets and said governments should have "well-defined exit strategies" for their banking rescues. The finance ministers also wanted to see the "registration" of hedge funds and to "disclose appropriate information on the risks they pose".
Lord Turner may well introduce proposals along those lines, and will also advocate tighter regulation of the "off balance sheet" activities of the banks and the various "special purpose vehicles" set up semi-secretly in offshore banking centres such as the Channel Islands and the Isle of Man. These were, for example, one of the main features that emerged during the various enquires into the failure of Northern Rock. For some months now world leaders have condemned these shadowy methods and called on the banks to declare all of their bad debts and to ensure that regulators are fully aware of them in future.
Also criticised during the recent crisis has been the tripartite structure of regulation – the split of responsibilities between the Treasury, the Bank of England and Financial Services Authority which Mr Brown instituted as Chancellor when he granted the Bank operational independence in 1997. Lord Turner will ask for tighter co-ordination between the three bodies, with a view to them monitoring much more closely the credit cycle. The Bank of England has made little secret of its preference for "countercyclical regulation" of the banks, which would be a logical step from an enhanced monitoring of the state of credit conditions in the economy.
The Prime Minister has backed the G20 ministers' calls for tighter regulation. During a press conference with German Chancellor Angela Merkel at the weekend, he said: "You are going to see a massive change in the supervisory system. It's going to include tax havens and institutions where it didn't before."
Last month, Lord Turner promised MPs on the Treasury Select Committee a "revolution" in banking regulation. The FSA is prepared to outlaw risky mortgages and investment banking products. In addition, it will hugely increase the amount of capital banks are required to hold to set against risky trading strategies, Lord Turner has already disclosed. Lord Turner's review is bound to remind critics of its past performance. The FSA has consistently rejected the accusation that it exercised a "light touch", insisting that its approach was "principles based".
Lord Turner took over as chairman of the FSA in September from Sir Callum McCarthy. Hector Sants replaced John Tiner as chief executive in July 2007, just as the credit crunch began in earnest. Lord Turner said that only with hindsight could he say that he would not have taken a similar approach to his predecessors and that the crisis had shown that regulators had to intervene because banks were unable to moderate their activities alone.Reuse content