It’s a pleasure to be here today to speak at the Atlantic Council, and especially on the important and pressing matter of global economic stability. The Atlantic Council has an important role in galvanising political leadership, here in the US and across the world, to work together to restore economic stability and growth in these tough times.
Looking through the history of the Atlantic Council I came across the Council’s core conviction,
that a healthy transatlantic relationship is fundamental to progress in organizing a strong international system.
It’s a sentiment that I share as we emerge from the shadow of the financial crisis. Because the UK and the US face a number of common challenges in the aftermath of the crisis …to restore confidence in our financial sectors … correct chronic regulatory failures…and fundamentally, tackle the imbalances in our respective economies, to provide a platform for stronger growth.
It’s clear now that the imbalances that developed in the decade before the crisis were utterly unsustainable. Whilst some exporting countries amassed massive trade surpluses, the counterpart was deficits and credit-backed consumer booms in others including ours. These imbalances helped fuel the financial crisis and now risk weighing down on global recovery.
As was agreed at the G20 in Seoul last year, and as we are discussing through the IMF, we have to work together to bring global imbalances to a sustainable level.
However, despite these commitments, and despite imbalances contracting sharply during the crisis, there is evidence that they are widening again. We have to convert good intentions into clear, credible, concrete policy commitments.
If we do not deliver real progress on reducing these imbalances we will either revert to pre-crisis unsustainable growth or face a black-hole in global demand as leading deficit economies deleverage to correct their own imbalances.
And looking at the situation in the UK, we face no small task as we rebalance away from a decade of debt-fuelled growth. In fact, pre-crisis household debt in the UK had exploded to almost 100% of GDP, compared to 61% in Germany and 50% in France.
Debt of non-financial companies exceeded that and reached 110% of GDP. The banks happily fed this frenzy, with the balance sheets of UK banks rising from around 300% of GDP in 1998 to a staggering 550% just a decade later.
And the impact of the crisis on the UK economy was correspondingly severe. A substantial cost as a result of taxpayer interventions to support the financial sector…lost output due to the impact on the wider economy…and a huge increase in Government debt.
When we came to Government just over a year ago, we inherited the largest peacetime deficit in the UK’s history.
But we have taken the difficult decisions to put our house in order. We have set out our plans to eliminate the structural current deficit by 2015 and we remain on track.
Of course, recovery following a crisis like the last will always be choppy, and even more so against a backdrop of real international instability. Today the Office of National Statistics estimated UK GDP growth in Q2 to be 0.2%, providing positive news that even in such a difficult international environment, the British economy is continuing to grow and create jobs. Indeed in the last twelve months:
- output has grown
- half a million new private sector jobs have been created
- and the interest rates on our bonds have continued to fall
In March this year we published our Plan for Growth to build on this progress to put the UK on a path to sustainable, long term growth. To promote a recovery based on export and investment.
And to do so we need to arrest the decade long decline in our international competitiveness. We want to reform our tax system to make it the most competitive in the G20, including cutting corporation tax to the lowest level in the G7.
We also want to make the UK the best place in Europe to start, finance and grow a business. We are lifting the regulatory burden by scrapping plans for regulations that would have cost businesses over £350m a year. And of course businesses need credit to grow and we have secured the agreement of the UK’s biggest banks to increase credit available to businesses by up to £190bn in 2011.
We are also investing nearly £200bn over the next five years in UK infrastructure to stimulate growth in sectors where we are already strong like construction, but also spur future high growth industries from advanced manufacturing to the digital and online sectors.
And hand in hand with that we have to ensure we have a workforce skilled enough to lead these new industries so we are investing in apprenticeships and technical colleges across the country.
Growth won’t come easy. But we have taken difficult decisions to lay the foundations for a sustainable recovery. To balance our books and support our private sector.
But we only have to look at the continued instability in the Eurozone to see what happens if you don’t take these difficult decisions.
The crisis in the Eurozone has its origins in the failure of some periphery nations to deal with a combination of unsustainable public finances, weak financial institutions, and poor growth prospects. And as the crisis spread, it became clear that the Eurozone as a whole did not have the instruments necessary to prevent contagion.
What we are seeing unfold is the remorseless logic of monetary union leading to greater fiscal integration. Last week’s summit was a welcome and overdue step forward, but there is more to do to improve the overall agreement reached.
This government has made it clear that we have no intention of joining the single currency. But a successful euro is in the overwhelming interests of Britain. So we will play a constructive role within the EU to enable to Eurozone to take the action necessary for the euro to succeed.
So while there will be more integration on some issues within the Eurozone, many other issues, such as financial regulation, are matters for all EU member states. London is Europe’s international financial centre, and PM Cameron, Chancellor Osborne and I are all absolutely determined to ensure the UK continues to play an active and vocal role in reforming financial regulation in Europe and the world.
And we will continue to make the case in Europe and elsewhere for open markets, greater transparency, high standards and global coordination.
The continued fragility in the Eurozone also reminds us just how intertwined the health of our economies are with our financial sectors. How closely the creditworthiness of banks and sovereigns are interlinked.
This is why the additional transparency from the recent EBA’s recent stress tests are so important, and why we must ensure that our banks are sufficiently well capitalised to be able to survive potential shocks.
The UK and the US have both benefited by being pro-actively transparent on the health of our banks, and recapitalising those in need.
But that doesn’t change the fact that the costs of these interventions and the subsequent impact on the real economy are costs that we cannot afford to repeat.
Domestically and internationally we are pursuing an ambitious agenda of regulatory and market reform to ensure that’s the case.
But herein lies a dilemma that both we and the US have to face. This year London and New York ranked first and second respectively in the Global Financial Centres Index. Our financial services generate hundreds of thousands of jobs, provide essential tax receipts, and remain a vital engine in our national economies.
But, whilst we strive for global success in financial services, it’s clear that success should not come at the cost of wider economic stability. And so we face a sharp dilemma - how can we create a successful, competitive but stable financial services sector?
And I believe that we can do so by:
- ensuring the right system and culture of domestic regulation, and in particular increasing regulators’ focus on system-wide risks
- ensuring consistent international standards and
- ensuring that the taxpayer is not on the hook if a “too-big-to-fail” bank does in fact fail.
Taking domestic regulation first, we are fundamentally reforming the tripartite system of regulation that our predecessors put in place. A system which failed spectacularly in its mission to maintain financial stability because neither the Treasury, the Bank of England nor the Financial Services Authority took responsibility for assessing systemic risk.
In the run up to the crisis, the focus was on the risks posed by individual institutions. No one was monitoring the systemic risks posed by the complex interconnections within and across financial markets.
Here in the US, the Dodd-Frank Act established the Financial Stability Oversight Council to remedy the flaw. In the UK we are establishing the Financial Policy Committee, sitting within the Bank of England, to bring greater focus to macro-prudential risks, recognising the interdependencies between financial stability, macroeconomic stability, and economic growth.
The FPC will monitor overall risks in the financial system, identify bubbles as they develop, spot dangerous interconnections and stop excessive levels of leverage before it’s too late.
But the FPC’s approach needs to evolve as the market evolves. Regulation should not be static but needs to adapt as markets continuously innovate.
And, as I’ll come back to later, we believe it’s crucial that regulators have tools, such as counter-cyclical capital buffers, to address systemic risks.
Of course, regulation at a domestic level is not enough. Financial services are a truly international industry and regulation must reflect that fact.
In such a fluid, open and competitive market as finance, it is vital that rules are consistent between national authorities. Not only to avoid fragmented and uncompetitive markets, but also to ensure that regulation is credible and effective.
And we must not dismiss the near cataclysmic events of recent years as a one-off. History shows us that is far from the case… in the last 200 years, the US and UK between them have had over 20 banking crises. And there is evidence to suggest that, globally, crises have become more, not less, frequent in recent decades.
So interconnected are our global markets that international cooperation and ambition is crucial to strengthening global financial markets against potential global risks.
The IMF, the G20, and the Financial Stability Board are central to taking this agenda forward.
Of course, in many ways Basel provides the most striking example of the kind of ambitious reform that international cooperation can achieve. A consensus on some of the biggest changes to bank capital and liquidity requirements that we have ever seen.
And as the UK, the US and the other G20 countries all agreed, and I quote “We are committed to adopt and implement fully these standards.”
That’s why it is incredibly disappointing to see resistance on the implementation of Basel, including from some G20 signatories.
Yes, the global economy is still suffering from the aftershocks of the crisis, but that is no reason to shy away from fundamental reform.
We need to avoid reforms that would be counterproductive in the current market conditions, but the lengthy transition timetable in Basel already caters for the continuing economic uncertainties.
Implementing Basel in full means ensuring that instruments qualifying as Core Tier 1 capital must meet the legal form of ordinary shares…
Entrenching rigorous and consistent liquidity standards through the Basel Liquidity Coverage Ratio and the Net Stable Funding Ratio on a Pillar 1 basis…
Implementing and disclosing a leverage ratio on a Pillar 1 basis…
And finally, we believe that counter-cyclical buffers will be an important part of the UK’s regulatory toolkit. Whilst not every home state regulator will use this at all times, it is vital that we all agree to the principle of jurisdictional reciprocity.
Without this principle, the result is distorted competition, a fragmented market, and an undermining of a key macro-prudential tool to lean against a credit bubble in an individual economy.
But we must also appreciate that Basel alone may not be enough to ensure stability of the largest, global, systemically important financial firms. This presents a particular challenge to the UK because of the size of our banking sector relative to the economy as a whole.
We have sought to address this by setting up an Independent Commission to look at the risks posed to financial and economic stability by UK banks.
This April, the Commission put forward to important proposals in its Interim report, both of which the Government endorses in principle.
Firstly, bail-in instead of bail-out so that private investors, not taxpayers, bear the losses if things go wrong.
Secondly, the interim report proposed a ring fence around deposit taking functions, and prohibiting certain investment and wholesale banking activities, including proprietary trading, within this ring fence.
Such a ring fence would shield the retail bank from risks elsewhere in the bank or system, and in the event of bank failure, it would allow for vital retail operations to continue while commercial solutions were found for other operations of the bank.
The Financial Stability Board has also recently announced outline proposals for systemically important banks to be subject to a capital surcharge above the Basel III minimum, reflecting the unique risk that they pose to the wider economy.
We agree with the need for these surcharges and we must work together through the G20 to reach agreement on an international basis.
But even with these changes, we cannot reduce risk to zero. There is still the risk that a global, systemically important firm fails.
Internationally consistent Recovery & Resolution plans and resolution toolkits play a central role in addressing these risks and providing for the resolution of failing banks without recourse to taxpayers money. In the UK we have learnt the lessons of the crisis.
We have already put in place a Special Resolution Regime to deal with failing financial institutions and we are leading pilot projects on “Living Wills”.
But these tools must be developed uniformly across the board. Only then can we ensure that we are regulating for a level playing field.
As well as working together to reform our regulatory apparatus, we have to demonstrate the same cooperation when it comes to wider market reforms.
We already have a general consensus at the G20 that we need to move towards the central clearing of derivatives. And the UK, like the US, believes that the central clearing obligation must be consistent across products, and apply to all derivatives and not just OTC.
But the rules also need to be consistent across jurisdictions. I’m sure many here are aware of concerns in Europe about the implications of some aspects of the Dodd Frank Act on cross border business with respect to derivatives clearing.
I welcome the creation of the joint technical group between the US authorities and the European Commission to clarify the intention behind some of these provisions.
Similarly we must work together through the G20 and the International Organisation of Securities commissions to understand the regulatory requirements in the commodity derivatives market, and in particular understand the best approach to position limits within this market.
Ultimately, strong and effective international regulation will create a more successful and stable financial system.
The success and the competitiveness of London and New York have been based on the quality of our regulation and supervision. That reputation took a temporary hit in financial crisis but we have an opportunity to remedy the failures of the crisis through strong global standards.
Providing the EU and US cooperate to implement those standards in full, that opportunity for growth will be real. If the EU and US seek to compete on regulation or engage in isolationist or extra-territorial practices then our comparative advantage will be lost.
We should not fall into the trap of short term gain if we are serious about maintaining our global competitiveness.
But financial sector reform and competitiveness is only one part of the puzzle. Countries across the globe including the UK face the sizeable task of rebalancing our economies away from the debt-fuelled consumption of the last decade.
Each member of the G20 faces its own challenges and will deal with them in their own way. But it is clear that we need to take action on global economic imbalances if we are to create a more stable economy.
In addressing the challenges of financial and economic stability, the UK and the US can lead the way.
Two months ago, almost to the day, President Obama delivered his speech to Parliament at Westminster Hall in which he said: “At a time when threats and challenges require nations to work in concert with one another, the US and UK remain the greatest catalysts for global action.”
By working together, the UK and the US can lead from the front to reform international financial regulation, rebalance our domestic and global economies, and ensure a sustainable recovery.
I look forward to working with many of you here to rise to these challenges.