Central Banks Need Redefined Role
Morris, From Bailey, The Independent (London, England)
LET US start with the proposition that central bankers and other regulators of the international financial marketplace are dinosaurs. Their failure to adapt to the sophisticated technology, increasing complexity and growing opaqueness of global markets will render many extinct. On the other hand, changing climates also can produce remarkable evolutions and that is the challenge faced by central bankers and the increasingly less relevant banks that they regulate.
It seemed entirely appropriate for the world's 103 leading banks to gather in London last week during the 300th anniversary celebration of the Bank of England to ponder their collective futures. On the one hand, their traditional deposit-taking, credit-gathering franchises have been rendered nearly obsolete by the proliferation of non-banks - finance companies, insurance companies, mutual funds and others - that perform similar functions. However, most of these big bank players have adapted with remarkable agility to the aggressive new world of risk-taking, in which derivatives and other sophisticated financial products play a starring role. As Sir Dennis Weatherstone, chairman of this year's International Monetary Conference (IMC), stated in his opening remarks: "To measure, manage and accept risk is our challenge." The big question for banks is will regulators allow them a level playing field on which to compete?
From the regulators' point of view, the movement of the traditional deposit-takers and others into the uncharted world of derivatives is both frightening and positive. An important function of central banks is to guard against systemic risk. Yet most of their safety mechanisms are tailored to a pre-derivatives world. The huge losses generated by hedge funds send shudders through the system, and the ultra vires cases involving UK local authorities glaringly expose some of the holes. Inevitably, central bankers must ask themselves central questions: do they have enough knowledge to prevent a systemic breakdown? What happens to the system if a big non-regulated player folds? Would central banks intervene to save a huge investment bank such as Goldman Sachs, which is not under their purview?
According to Alan Greenspan, chairman of the US Federal Reserve Board, there are no solid answers. Mr Greenspan told IMC delegates that the system is now so complex that the ability of central banks to contain volatility by imposing more regulation is doubtful. He repeated his call for more sophisticated self- regulation of financial institutions, because "government regulators can no longer do that job". This would mean the gradual reduction of the direct supervision of risk by central banks to a role of monitoring internal risk-management systems. Implicit in Mr Greenspan's remarks is an acknowledgment that derivatives can play a positive role - distributing risk throughout the global system in a relatively controlled manner. …