But they are, and always will be, a second best. There will always, for example, be a risk of reputational contagion. Counterparties might refuse to deal with a member of a failed group because they are unwilling to take the risk that the firewalls may be flawed, or that cultural or control weaknesses which led to the failure are repeated in that entity also. This, of course, is a hypothetical risk but one which does concern supervisors. Secondly, as the firm will incur additional costs in order to comply with these ringfencing arrangements, while possibly at the same time being denied the risk reducing benefits of group wide controls, it is unlikely to provide the most efficient solution. Concern about these deficiencies has heightened as we have learned more about the way in which many global financial groups are managed. The lack of overlap between legal entities and the management of business lines means that the amount of true ring-fencing which is possible for a globally managed institution is open to debate. The creation of ring-fenced islands of activity seems to me contrary both to the trend in markets and second-best in terms of regulatory efficiency. The Bank of England has always believed that effective supervision of financial groups must involve consolidated supervision. As Alan Greenspan said last week in his testimony to the Congressional SubCommittee on Financial Institutions and Consumer Credit, “Risks managed on a consolidated basis cannot be reviewed on an individual legal entity basis by different supervisors”.
Mr. Davies reviews current debates on regulatory structures governing the financial system Speech by the Deputy Governor of the Bank of England, Mr. Howard Davies, held on 22/2/97 at the Federal Reserve Bank of Atlanta’s Financial Markets Conference entitled ‘Market and Regulatory Structures in a Global Environment’. It is conventional, and polite to say, at the beginning of a speech of this kind, that one is thrilled to have been asked to speak on the subject of the structure of financial regulation and that the topic is, of all the many preoccupations of human kind through the centuries, the one which generates the most enthusiasm and excitement in one’s breast. But I cannot bring myself to do it. You may think me ill-brought up to say this if so blame my parents - but I find the question of the structure of regulation to be quite resistible. I know that there are those who like nothing better than to draw new organigrams and to explore the manifold interfaces between regulatory agencies. (There are also people who find self-fulfilment collecting airline sick bags, or watching synchronised swimming. That is a matter for them.) But my lack of enthusiasm for the topic of regulatory structure is, I hope, not an emotional response. It is rationally based on two prior beliefs. First, that the relationship between structure and effectiveness is loose. I know of little evidence that structural reforms are quickly followed by an enhancement of the effectiveness of the activity in which those agencies are engaged.