The global economy has wresteld with financial stability issues and a lack of growth following the emergence of huge structural issues triggered by Lehmans. The problems are well documented but solutions have proven elusive.
Carneys prescription is impressive, not for it's innovation, but for it's clarity.
He argues that banks are crucial and integral to stability and growth, that their absolute size has become a distracting obsession, and that the crucial focus must be on making the system resilient to shocks, whilst fostering banks ability to lend money and take on risk to support the real economy:-
"As we have recently been painfully reminded, a specialisation in financial services carries risks as well as rewards. And those risks will grow, unless we put global banks and markets on a sounder footing. Suppose, for example, that UK-owned banks’ share of global banking activity remains the same and that financial deepening in foreign economies increases in line with historical norms. By 2050, UK banks’ assets could exceed nine times GDP, and that is to say nothing of the potentially rapid growth of foreign banking and shadow banking based in London.
Some would react to this prospect with horror. They would prefer that the UK financial services industry be slimmed down if not shut down. In the aftermath of the crisis, such sentiments have gone largely unchallenged."
But Carney goes on to explain that we must not be blinded by the past or the risks, but look beyond them to solutions that allow banking to make an essential contribution safely:-
"But, if organised properly, a vibrant financial sector brings substantial benefits. Today financial services account for a tenth of UK GDP and are the source of over 1 million jobs."
"More broadly, London’s markets serve a vital global role. London acts as Europe’s window to global capital; is a centre of emerging market finance; and can play an important role in the financial opening of China."
"The UK’s financial sector can be both a global good and a national asset – if it is resilient."
"It is not for the Bank of England to decide how big the financial sector should be. Our job is to ensure that it is safe. The UK can host a large and expanding financial sector safely, if we implement a reform agenda that extends well beyond domestic banking."
So how do we engineer strongly capitalised banks that can function and lend to the real economy stimulating and leading growth? The balance sheet repair work has come a long way with $500bn worth of global recapitalisation off the back of Basle. Banks are stronger, but they still need to be made safer. Global recovery and resolution regimes that do not rely on tax payer support are a vital component of the solution and in addition:-
"To finish the job, international regulators need to agree over the next year new rules for capital to be held in banks’ trading books, a simple leverage ratio and a guideline which governs the stability of banks’ funding"
"Alongside these efforts to increase resilience, our focus is on solving the problem of banks that are too big to fail. Systemic resilience depends on being able to resolve failing banks in a way that does not threaten the entire system. Fairness demands the end of a system that privatises gains but socialises losses. And simple economics dictates that the UK state cannot stand behind a banking system that is already many times the size of the economy."
But this is the single most important aspect of the speech:-
"Five simple words describe our approach: we are open for business."
Our facilities are not ornamental. They are there to be used by banks to access money and high-quality collateral. We are offering money and collateral for longer terms. The range of assets we will accept in exchange will be wider, extending to raw loans and, in fact, any asset of which we are capable of assessing the risks. And using our facilities will be cheaper. In some cases the fees are being more than halved.
Banks can be confident that, when they want to use our facilities, they will be allowed to access them.
An institution that has feared moral hazard for decades, which was slow to move in on Northern Rock and provide the necessary support in the early crisis period, is now signalling it will play an active role in the market. For the moment this has less significance with the funding for lending and home buying support schemes currently in play, but the symbolism demonstrated in these actions is immense.
With stronger capital and liquidity in place, well run banks can turn to the BOE at any time for competitively priced funding. The spectre of wholesale funding drying up is removed , and with it the fear of extending support to business in case lines cannot be renewed.
This could and should signal a turning point in the UK banking industry, increasing its ability to suport the real economy, wealth creation and jobs.
The governor's message is one of tough love; observe the rules, carry the capital buffers you need, don't over leverage, keep the right liquidity, organise to protect depositors and we will help you. If you get it wrong, we will guide you off the pitch, and you will take no further part in the game.
I will let Governor Carney have the last word:-
"The Bank of England today is the friend of resilient banks, continuous markets, and good collateral; and we are the enemy of taxpayer bailouts, fragile markets and financial instability."