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Thursday, February 18, 2010

Focus on basic financial services: Turner to India

Not many in the world of high finance would dare talk of tighter regulation even after the credit crisis for fear of being branded anti-free market. But Adair Turner, chairman of the UK's beleaguered Financial Services Authority (FSA), worked hard to get the world agree to tighter scrutiny. He shares his views on a wide variety of topics such as his experience as a regulator and policy options for India in a free-wheeling interview with ET's Deepshikha Sikarwar & Vinay Pandey. Excerpts: 


Have the agenda of financial sector reforms taken a back seat after the recovery? 
No, I think we are in the process of producing a significant change in the global financial regulatory architecture. We have an extensive agenda that will lead to concrete decisions later this year. I don't think there has been any drawing back as recovery gets under way. 
Will a change in the architecture of global finance affect capital flows? 
I don't think so. The changes will not affect the flow of capital across the world in terms of attracting capital because capital can come in many forms. It can come as longterm direct investment, equity portfolio and as debt securities. None of that is affected by what we are doing. What will be affected is the flows that go through the 
banking system. A stable banking system means it will be less easy to extend crossborder credit on an upswing. But we know that sudden increases of cross-border credit on an upswing will be followed by withdrawals, which is quite destabilising. 
What is the case for financial innovation, post the financial crisis? 
We simply need to be more sceptical about the claim that extra financial innovation and extra financial intensity are always valuable. A major distinction has to be drawn here between the condition of a country like India, where there are lots of people who don't have access to basic banking services, and where a process of financial deepening would be valuable. What we wrongly assumed in the past is that financial deepening means more trading activity and more financial innovation. I think it is not obvious that the explosion of fancy financial innovation in America and the UK actually was economically beneficial. 
Do sophisticated financial instruments have a role in an economy such as India? 
I think some of those products have a role to play. But I don't think they are the priority for India. 
THE priority for India is a good competitive market in the provision of basic banking and insurance services to the population and to small and medium enterprises. This is more important than complex instruments. 
Do you see a big risk of large capital flows into the emerging economies like India? 
We all know that was one of the causes of the problems in 1997 in countries like Korea, Thailand and Malaysia. You had big hot money flows going into the banking system, into commercial real estate, speculation and then when there was a crisis of confidence, they suddenly went out. Now, a lot of those countries have very large foreign exchange reserves which can cushion sudden capital flights. We have to be pragmatic about short-term capital flows. There really isn't much economic value added to the world in carry trade. Now, there isn't much we can do about it and we shouldn't fool ourselves that we can ever stop that entirely because carry trade can be done almost alongside commercial activities once you have global corporates which are moving money around. But we should at least be open to some sort of tax restriction on short-term flows. If somebody takes a local portfolio investment in debt securities or equity securities, 
you can have a tax, which doesn't apply if they hold for a longer period of time. 
Does that mean there would be a greater understanding of such measures in the developed world? 
Oh yes, I think there will be. Before the crisis, there was an over simplistic belief in free market among some people, which has always been debated among economists. There is now a greater appreciation of the inherent instability of the markets and therefore, an understanding that we have to be open to a set of pragmatic responses to deal with some of these problems. We will see a pragmatic understanding when countries like India use a variety of tools to slow down the more speculative forms of short-term capital. 
There has been this whole debate about foreign money coming... 
I am not familiar with the details of how that works. In the real world of globalised economies, it is difficult to have total control because when you try and control one thing there will be some other instrument that takes the economic substance of it. One has to realise that a lot of these instruments of control are not perfect, but they are not useless either. 
You advocated taxing capital flows at the G20, but it was not well received.. 

There has always been a distinction between the theoretical attraction and the practical difficulty of doing it. There are a number of economists over the years who expressed sympathy for it because a rational analysis of how financial markets work suggests that there would be nothing wrong about a small transactions tax. Again, you must not imagine it will transform things. The Brazilian tax which they have just introduced is a form of financial transaction tax on short-term capital flows. I have never said we have got to have a Tobin tax. All I have said is that we should be willing to consider openly. Because it came at a time when there was sort of free market hype, it was considered an offence against the total free market creed. 
Will a co-ordinated approach within the emerging world would be a better idea? 
It would make sense. It is not for me to try and orchestrate that. It's for emerging markets to get together and talk about it. That might be helpful. 
If India were to raise rates unilaterally, it would risk attracting hot money. This dilemma must be faced by many countries. How will the world address the issue? 
This is the fundamental problem of a monetary policy in the environment of floating exchange rates and free capital. There are no perfect solutions to this in monetary policy and 
exchange rate mechanism. Now for India, it is less of a problem than, say, a Thailand or Malaysia. India is a continental scale economy. Problems will be huge for smaller economies. I think for a country like India, the problems will be manageable, but for smaller countries this can be problematic. 
In the UK there is debate about the future of FSA. For long, we in India have been debating a single regulator and the model was FSA. So where do things stand? 
Often when people can see problems, they think the solution is to move around organisational boxes. Therefore, given that we all have problems as always some people are suggesting one thing and other people are suggesting exactly the opposite. In the UK the Conservative Party wants to recombine a prudential supervision particularly of banks with other things with the central bank. Our systemic moment has some benefits and one disbenefit. Our benefit is that we have prudential supervision altogether in one organisation. That is clearly an advantage compared with, say, the US where the separation between the SEC and the insurance regulator and OCC and the Fed led to the phenomenon of AIG which just escaped regulation because everybody thought it was a sort of insurance company but actually it was doing investment banking business. And so there is a 
lot to said for having one authority which can span over all of the prudential activities. And argument for that actually becomes stronger the more sophisticated and complex is your financial system because the more your financial system develops the more there is a possibility of AIG type institutions which do not fit into categories. So that's the argument for putting it altogether. The argument against there are two. One is that there is a very large span if you are also doing customer protection but the other more important one is that you can lose integration with the central bank. Because in particular in what is called the macro prudential policy which resides half way between monetary policy and pure prudential policy. So this is looking at credit aggregates, the overall supply of credit to the economy and if necessary slowing it down by sort of tools I described earlier. That can get lost between the regulator and the central bank. Whatever you do, how ever you do, you do not have a perfect solution here. 
Do you see greater conservatism on part of regulators going ahead? 
Yes. We are much more conservative. We use to talk about light touch regulation. We use to think of competitiveness.. We were encouraged to think of competitive of London versus other financial centres as a major aim for the regulator, which I think is a mistake.

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