Earlier this week, the U.K. Financial Services Authority (FSA) released The Turner Review: A Global Response to the Global Banking Crisis. Props to Martin Wolf and Jennifer Hughes of the Financial Times for reporting on issuance of the FSA's report, in Wolf's article on March 20, Why The Turner Report is a Watershed for Finance, and Hughes article March 19, Accounting Plan Sparks Strong Debate.
As noted in the FSA's press release, "Lord Turner, chairman of the FSA, was asked by the Chancellor of the Exchequer to review the events that led to the financial crisis and to recommend reforms. The Review identifies three underlying causes of the crisis:
· macro-economic imbalances,
· financial innovation of little social value and
· important deficiencies in key bank capital and liquidity regulations"
" These were underpinned by an exaggerated faith in rational and self-correcting markets," the FSA states. Therefore, the Turner Review "stresses the importance of regulation and supervision being based on a system-wide "macro-prudential" approach rather than focusing solely on specific firms."
Concurrent with release of The Turner Review (aka the Review), the FSA issued a Discussion Paper (DP 09-2) to obtain comment by June 18 on the recommendations in the Review.
As summarized in this FSA newsletter: "The [Turner] Review sets out a wide-ranging series of changes that are needed to banking regulation and associated supervisory practice. In some areas the FSA can and will take action on its own, but in others international agreement will be needed. In particular:
fundamental changes are needed in the regulatory approach to capital, liquidity and accounting;
there needs to be a system-wide approach to identify and deal with macro-prudential risks, to complement stronger micro-prudential supervision of individual firms;
changes need to be made to the scope of regulation to make sure that the economic substance of activities are regulated, not the legal form; and
the international framework for the regulation and supervision of cross-border banks needs strengthening in the light of the crisis. As part of this the Review recommends a new European body which will be both a standard setter and overseer in the area of supervision.
"Hard-wired procyclicality" and inadequate capital buffers were among the factors which exacerbated the financial crisis, according to the Turner Review. Additionally, the report states that the growth of financial services as a % of GDP was fueled by "illusory effects" of mark-to-market in a rising market, specifically, that: "mark-to-market accounting helped fuel a self-reinforcing cycle of irrational exuberance," and there were 'harmful effects' of 'rent extraction.'
On this second point, the report notes: 'some and perhaps much of the structuring and trading activity involved in the complex version of securitised credit, was not required to deliver credit intermediation efficiently. Instead, it achieved an economic rent extraction made possible by the opacity of margins, the asymmetry of information and knowledge between end users of financial services and producers, and the structure of principal/agent relationships between investors and and companies and between companies and individual employees." The report continues: "when the crisis broke, banks did not have sufficient capital buffers to absorb losses, creating the danger of a self-reinforcing feedback loop between weak lending capacity, economic recession, and credit losses."
The Turner Review (the 'report') concludes these and other factors have implications for regulation, and offers seven recommendations to creating a sounder banking system:
1. Increasing the quantity and quality of bank capital.
2. Significant increases in trading book capital: and the need for fundamental review.
3. Avoiding procyclicality in Basel 2 implementation.
4. Creating counter-cyclical capital buffers.
5. Offsetting procyclicality in published accounts.
6. A gross leverage ratio backstop.
7. Containing liquidity risks: in individual banks and at the systemic level.
Read more details of the Turner Review's accounting-related recommendations, and related actions of the FASB and IASB, here.