Wednesday, October 15, 2008

Gordon should have read David's speech in March

This is part of a speech delivered by David Cameron on 28th March this year. The problems with the banking sector were recognised by the Conservatives. It took a banking sector shock and stock exchange collapse to get the government to catch up.

“As well as the reforms we have outlined for the UK financial system, we need reforms at a global level too. So let me suggest one important reform that needs to take place in light of the recent crisis in world banking.

“The Basel capital accords determine how much capital a bank must set aside for a given amount of lending. This makes good sense, and, for obvious reasons, it is right to set the rules at a global level. But economists have identified some key problems with the current Basel accord.

“First, the rules on liquidity, which has been at the core of the current crisis, are too weak. Banks can operate with enough funding only to survive for a couple of weeks, but still be within the rules. Second, we need to examine which asset classes and which institutions are covered by existing rules. For example, the zero-weighting of some triple A assets has led to distortions in asset allocation. Put simply, some of the debts were kept off balance sheet so they didn’t count as lending under the rules.

“Third, judgements about credit risk were delegated to rating agencies who themselves had incentives to expand the amount of lending that was allowed under the rules. Put simply, because they are paid fees for rating debts, credit rating agencies had an interest in there being as much debt as possible. Finally, market risk was measured by backward looking models which tend to exacerbate the credit cycle, not dampen it. When credit is easy, the models allow more lending. When credit tightens, the models reduce the amount of permitted lending.

“In short, liquidity risk was all but ignored, credit risk was delegated, and market risk was backward looking. And we now know that not only did the regulators not know, but too often the banks themselves didn’t know, the full extent of the risks they were subjected to.

This extract comes from conservativehome.blogs.com - a useful source of information, comment and opinion. The full speech can be found at http://www.conservatives.com/News/Speeches/2008/03/David_Cameron_A_Conservative_Economic_Strategy.aspx.

Richard Normington

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