Turner attacks growth of financial innovation

Sean Farrell,Financial Editor
Thursday 22 January 2009 01:00

The chairman of the City regulator last night attacked the growth of financial innovation for creating unreal profits, swelling bankers' bonuses and threatening financial stability.

Lord Turner said that much of the growth in financial services in the last decade was of little economic use and had increased risks. He added that the FSA and the Bank of England had failed to spot the systemic risk created by the combination of various economic and financial developments.

The increased role of financial services in driving economic growth was due to a surge in activity between financial institutions rather than in providing services to companies, he said. The sector's importance was swollen by rising asset prices which boosted bank profits and bankers' pay, encouraging the creation of even more complex products that allowed financial firms to cream off unjustified profits, he added.

"If by some terrible accident the world lost the knowledge required to manufacture one of our major drugs or vaccines, human welfare would be seriously harmed. If the instructions for creating a CDO squared have now been mislaid, we will I think get along quite well without," Lord Turner said in a speech. "Too much of the developed world's intellectual talent was devoted to ever more complex financial innovations."

Lord Turner, who joined the watchdog in September, said new capital rules for banks would require them to hold many times more capital against risky trading strategies. Liquidity rules would be based on market-wide risk as well as individual firms' positions, while financial activity that was akin to banking – such as off-balance sheet funds – would face the same scrutiny as banks, he added.

Regulators and central banks will have to work more closely together to identify risks building up in the financial system and the economy, he said.

"Regulators were too focused on the institution-by-institution supervision of idiosyncratic risk; central banks were too focused on monetary policy tightly defined, meeting inflation targets," he said.

He predicted that the market for securitisation – packaging up of bank assets to be sold as bonds – would return but in a less complex, safer form. Lord Turner rejected calls for a clear split between deposit-taking banks and investment banks, but said trading books at large banks would require more capital.

Lord Turner added that the Government's bank bailout plan would have a significant impact and that "if more measures are required they can and will be taken".

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