Too big to fail?

Mervyn King's impassioned address to Scottish business organisations yesterday has been described as a declaration of war on the banking industry which is fair enough considering his decision to paraphrase Sir Winston Churchill.

King's cri de coeur has been brewing for some time. Regulators and policy makers around the world have recognised that in pulling the financial system back from the brink we have created a new predicament. Previously, banks may have suspected that central banks would bail them out if they got into trouble but recent intervention has now proven that banks can indulge in risky business without risking salvation from the taxpayer.

King said that "The 'too important to fail' problem is too important to ignore" and that "The massive support extended to the banking sector around the world...has created possibly the biggest moral hazard in history". The powerful rhetoric employed in his speech shows how much is at stake if regulators waste this opportunity with ineffective reforms.

Little over a year ago, when Lehman's employees were looting office buildings and the rest of us were contemplating what it would be like to live through another great depression, there was a sense that these events would mark a sea change in financial services. Reform was long overdue and the industry as we then knew it would be a much different beast in the future. A year hence though, what has actually changed? With the return of bonuses and the recovery of risky assets, there is little sense that any lessons have been learned or that the culture of financial services has much altered.

King's speech may have focussed on banking but it speaks to a much bigger problem. Now the industry is back on its feet and making money the impetus for reform has been lost. Self-interest once again dominates discussions and the topic of regulatory reform is being turned into a showcase for politicians. Policy makers must recognise that more regulation is not necessarily better regulation and engage in open and honest dialogue, not polemics and posturing.

The battle over how best to address the 'too big to fail' quandary is a worthy fight but is just one conflict in a much bigger war that must be waged if we are to avoid another crisis of this scale.

NS