Regulating the City

"It's clear to me that the FSA has to be very, very wary of seeing the competitiveness of London as a major aim, and that's not a popular thing to say. . ." Thus did Lord Turner, chairman of the UK's Financial Services Authority, describe the regulator's future role in Prospect magazine. He was right, on both counts. So how should the authorities approach financial regulation in Britain?

The starting point has to be with the twin personality of UK financial services: the country has a large domestic industry; and it is also home to the world's leading international financial entrepot. Regulating the former is a different task from regulating the latter.

Taxpayers are the risk-bearers of last resort for much of the domestic financial sector, as this crisis has shown. They stand behind the institutions that hold the public's money, manage payments and lend to households and businesses. It is the job of the FSA to ensure that these risks are well-managed. It is evident that they were not, in the years leading up to the crisis.

Managing these risks involves more than affecting what these institutions do in the UK itself. Britain's regulators must represent the public interest when UK banks take on activities, assets or liabilities in the rest of the world. In conjunction with regulators abroad, they need to devise and implement rules governing capital and liquidity, product innovation, remuneration and so forth, to ensure that such a crisis will not recur for the foreseeable future.

Regulating the City's role as a financial entrepot, is a different matter, to the extent that the British public is not directly at risk. The core regulatory job here is to ensure that activities carried out in the UK neither undermine globally agreed financial rules nor threaten its own economy. It is important, for example, to ensure that the failure of global institutions with operations in the UK does not cause chaos, as happened after Lehman's collapse a year ago. Reforms to such bankruptcy arrangements remain a priority.

Subject to these provisos, the City should - and unquestionably will - remain a world-leading financial entrepot. The government itself should promote and protect valuable financial activities, via its policies on immigration and taxation. But the regulator's role is neither to promote the City nor to shrink it. It is to help make financial activities sound, both at home and abroad. This is in the true interest of the UK. Promoting activities likely to generate hugely expensive global crises is not.

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