Bank of England Praise for Spanish System

Banks should have to put aside reserves in times of boom that they can draw down in times of bust to prevent banking crises like the current one pulling down whole economies in their wake, Bank of England deputy governor Sir John Gieve argued.

He pointed to a system called "dynamic provisioning" in Spain as an example of a system which works well in that respect. Spanish banks have been notably unscathed by the credit crunch and remained conservative in their lending practices during that country's recent housing market boom, meaning they are not unduly threatened now that Spanish property prices are tumbling.

Outlining a series of practical regulatory measures that could prevent banks' behaviour getting out of hand in future and put flesh on the bones of Gordon Brown's and Alistair Darling's promises to clamp down on the excesses of the City, Gieve said the measures should be used alongside interest rate setting to provide the central bank with a better arsenal of tools to control the economy.

"In my view the case for macro-prudential policies alongside monetary policy is compelling," Gieve said in a speech. He said the international Financial Stability Forum, which is leading the international regulatory response to the crisis, was already considering the scope for such instruments to "dampen the destabilising procyclicality in financial markets".

"To do this we need to do more than simply raise the minimum levels of capital and liquidity that regulators, rating agencies, or the markets require. We need to create reserves based on macroeconomic factors, which can be drawn down as the cycle turns down and have to be replenished on the upswing when profits are high."

Gieve added: "One lesson of recent events is that the capital and liquidity buffers need to be higher for everyone. The long decline in holdings of liquid assets by banks for example has to be reversed a bit and the increase in leverage likewise."

Although Darling thinks there are considerable practical problems with forcing banks to make provisions during good times to draw on in bad, Gieve is a key part of government efforts to rein in some of the City's more dubious activities and therefore carries considerable weight. The FSA, for example, is already strengthening its prudential supervision.

Gieve called on other countries to help fill in the gaps in the current regulatory framework governing banks' activities.

"For example, on mortgage origination in the US, increasing the capital requirements for some credit products and loan commitments, and ensuring that investors and rating agencies assess new products more diligently."

Gieve also said he now thought that the dampening effect of the credit crunch on the economy could be bigger than previously thought - a possible hint that he could be leaning towards voting for an interest rate cut in the coming month or two.

"While we must remain vigilant for any signs of inflation expectations drifting upwards, the news on that front is encouraging. On the other side, the risk we must be careful not to underestimate is the deflationary consequences of the credit crisis."

Some economists who are critical of the Bank's monetary policy committee think it should be cutting interest rates rapidly now to prevent the economy tipping into a deep and prolonged recession. The MPC is concerned that inflation remains high and well above the target but should focus more on the rapid slowdown in the economy which, alongside falling oil prices, will soon push inflation down sharply, they say.

Story from The Guardian

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