David Prosser: Wanted: toolkit for financial regulator

Outlook The approaches taken by the UK and the US to reform of banking regulation are quite different, but one commonality is striking: on both sides of the Atlantic, policymakers are sticking with the regulatory authorities that many hold responsible for failing to prevent the financial crisis.

Over here, while Alistair Darling made it clear last night that next week's Treasury White Paper on financial regulation will contain plenty for the banks to worry about, he also insisted there was no need to dismantle the much-criticised tripartite approach to supervision in the UK. The Financial Services Authority will maintain its responsibilities for banking regulation, working in conjunction with the Treasury and the Bank of England.

Over there, President Obama yesterday pledged to beef up the powers of the US Federal Reserve, despite widespread complaints in Congress that the Fed did not properly discharge its responsibilities in the run-up to the crisis.

The implication of these outcomes is that neither the US nor the UK thinks the underlying structure of its regulation is holed beneath the water line (though there will be a rationalisation of various specialist American financial watchdogs). Instead, the emphasis is on new powers for regulators and more exacting requirements on the banks.

In fact, though the banks may protest, this is the easy part. That they should be required to hold more capital is a given. That issuers of complex securitisations should have to retain some exposure to what has so often proved to be toxic debt is impossible to argue. That opaque derivatives markets – particularly for credit default swaps – must be brought to heel no one can dispute. And an intense scrutiny of bank executives – both what they earn and whether they are properly qualified – is just as inevitable.

None of this, however, tackles the elephant in the room: how you ensure the sort of bubble we have just seen burst never inflates in the first place. This is what the US calls systemic risk, while in the UK we prefer the term macro-prudential.

For all the criticism of regulators – much of it deserved – they never had the power to do anything about the credit boom of the decade that led up to the financial crisis.

Nor do they yet. The Fed was yesterday handed a wider responsibility for monitoring systemic risk, just as the Bank of England was earlier this year given a statutory duty to maintain financial stability. But it is not yet clear what tools either one of them is to get to help them achieve these goals.

Mervyn King said as much last night, employing a rather cute simile comparing the Bank to a church "whose congregation attends weddings and burials but ignores the sermons in between".

But here's the problem. Even Mr King concedes that he has not yet formed a view on what should be in the macro-prudential toolkit. Some sort of credit control authority seems sensible, though even this would be a reform designed to tackle the crisis just passed – the next crisis may be of a completely different nature.

In the absence of a clear view – and the Governor very fairly pleads for time to come to one – it is curious that both Washington and London seemed to have already dismissed one way of dealing with the question of systemic risk. One lesson from the crisis has been the "too big to fail" problem, yet there seems to be no appetite at all for the break-up of banks that fall into this category.

Preventing a financial institution becoming too big to fail, or dismantling those banks already in that category, may indeed be the wrong way to tackle systemic risk. But the dismissal of even the idea of such an option in both the US and the UK before we have devised a better plan smacks of a worrying timidity.