Lord Turner: Admit it: a bigger financial system is not necessarily a better one

The banking system is stable. House prices have fallen much less than anticipated. Big emerging economies have proved far more robust than we feared. The Bank of England mid-point forecast suggests fairly robust UK growth over the next three years. But we need radical change.

Regulators must design radically changed regulations and supervisory approaches, but we also need to challenge our entire past philosophy of regulation. And parts of the financial services industries need to reflect deeply on their role in the economy, and to recommit to a focus on their essential social and economic functions, if they are to regain public trust

The financial system plays vital roles in a market economy and particularly so in a complex global economy of global trade and global capital flows.

The City is a centre of huge expertise in the full range of these activities. It is, and will continue to be, a major provider of wholesale financial services to the rest of Europe and the world. And it is important to understand, amid the public suspicion of traders and trading rooms, that market making and liquidity provision in key markets is an important economic function, delivering important indirect economic benefits – even when the traders involved are focused day-by-day simply on making money, even though their activities look to some people like pure speculation, even though they do indeed entail position-taking for speculative gain.

But it's possible to say all of that, and also recognise that not all financial innovation is valuable, not all trading plays a useful role, and that a bigger financial system is not necessarily a better one.

Indeed, there are good reasons for believing that the financial industry, more than any other sector of the economy, has an ability to generate unnecessary demand for its own services - that more trading and more financial innovation can under some circumstances create harmful volatility against which customers have to hedge, creating more demand for trading liquidity and innovative products; that parts of the financial services industry have a unique ability to attract to themselves unnecessarily high returns and create instability which harms the rest of society.

Taken from a speech by the Chairman of the Financial Services Authority to the City Banquet at Mansion House on Tuesday