Global reform of financial regulation must not choke off economic growth

Mark Boleat
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GROWTH forecasts were slashed by the IMF last week in the latest sign that severe headwinds are pushing the global economy closer to a stall.

The Eurozone crisis, the so-called US “fiscal cliff” and the slowing pace of development in the Brics all pose considerable threats if mishandled by policymakers.

It is positive, therefore, that politicians and regulators are increasingly coming to realise what many in the City have been aware of for a long time – namely that there is clear trade-off between tighter regulation and growth.

Last week’s announcement that the FSA has eased capital and liquidity requirements for UK banks as part of the “funding for lending” scheme was a sensible step in the right direction. This should, as outlined by Andrew Bailey, provide the flexibility needed for the sector to avoid the kind of excessively rapid deleveraging that would hurt businesses seeking funding across the country.

This innovative use of macroprudential policy to provide a countercyclical boost to lending and ultimately growth is a welcome shift in a debate that has previously focused – almost exclusively – on ever tighter regulation.

Regulatory reform in the banking sector has a direct impact on the economy. There is a price to pay for higher capital requirements outlined by Basel III and the wide range of other restrictions imposed by domestic regulators. After all, the safest bank is the one that chooses not to lend any money.

It is vital that the deleveraging undertaken by UK banks in recent years does not turn into a vicious circle – as we are already seeing in some European countries. Indeed, the IMF has warned that a failure to resolve the Eurozone crisis could lead to the region’s banks shedding $2.8 trillion worth of assets – more than 7 per cent of their balance sheets – by the end of next year. Needless to say this would have a substantial impact on growth and already record high unemployment.

As governments across the globe seek to cut debt levels, it is imperative that growth is not choked off as they drive through financial reforms to address the last crisis. To paraphrase Andrew Haldane’s (the executive director for financial stability at the Bank of England) insightful analysis of the banking regulation landscape: more complex regulation is not the same as better regulation.

In these times of austerity, it seems clear that the regulatory response needs to support growth, rather than act as yet another headwind. The FSA has made a welcome signal of intent that is hopefully indicative of how the Bank of England will approach this issue when it takes on the combined role of monetary policy, banking supervision and financial stability next year.

Mark Boleat is policy chairman at the City of London Corporation.