The Review identifies three underlying causes of the crisis – macro-economic imbalances, financial innovation of little social value and important deficiencies in key bank capital and liquidity regulations. These were underpinned by an exaggerated faith in rational and self-correcting markets.
It stresses the importance of regulation and supervision being based on a system-wide "macro-prudential" approach rather than focussing solely on specific firms. It recommends:
Fundamental changes to bank capital and liquidity regulations and to bank published accounts;
More and higher quality bank capital, with several times as much capital required to support risky trading activity;
Counter-cyclical capital buffers, building up in good economic times so that they can be drawn on in downturns, and reflected in published account estimates of future potential losses;
A central role for much tighter regulation of liquidity;
Regulation of "shadow banking" activities on the basis of economic substance not legal form: increased reporting requirements for unregulated financial institutions such as hedge funds, and regulator powers to extend capital regulation;
Regulation of Credit Rating Agencies to limit conflicts of interest and inappropriate application of rating techniques;
National and international action to ensure that remuneration policies are designed to discourage excessive risk-taking;
Major changes in the FSA’s supervisory approach, building on the existing Supervisory Enhancement Programme (SEP), with a focus on business strategies and system wide risks, rather than internal processes and structures; and
Major reforms in the regulation of the European banking market, combining a new European regulatory authority and increased national powers to constrain risky cross-border activity.
The Turner Review distinguishes between those areas where the FSA has already taken action, those where the FSA can proceed nationally, and those where international agreement needs to be achieved. It also recognises that there may be alternative specific ways to achieve the essential objectives of effective regulation.
In addition the Review highlights areas where it is premature to recommend specific action, but where wide-ranging options need to be debated. These include product regulation in retail (e.g. mortgage) and wholesale (e.g. CDS) markets.
Lord Turner said: "The financial crisis has challenged the intellectual assumptions on which previous regulatory approaches were largely built, and in particular the theory of rational and self-correcting markets. Much financial innovation has proved of little value, and market discipline of individual bank strategies has often proved ineffective.
"A global market economy remains the best means of delivering global prosperity: it requires a global banking system focussed on serving the needs of businesses and households, not in taking risks for quick return. Major changes in regulation and in supervisory approach are required to deliver that. The approach has to build on a system-wide perspective: failure to look at the big picture was far more important to the origins of the crisis than any specific failures in supervising individual firms. And it must reflect the reality of a global financial system without a global government; we need both far more intense international cooperation and greater use of national powers.
"The changes recommended are profound, and the banking system of the future will be different from that of the last decade. The world’s economy will be better served as a result."
Lord Turner warns that the transition to higher bank capital will need to be managed carefully. UK banks are now capitalised at a level which will enable them to absorb severe stresses, and the short-term priority is to maintain bank lending to the real economy.
Published alongside the Review is an FSA discussion paper (DP) which sets out more detail on specific policy proposals. As the current crisis arose in the banking, investment banking and "shadow banking" sectors, most of these proposals focus on these sectors. Possible implications for some other sectors are however identified.
Commenting on the publication of the Turner review on bank regulation, Liberal Democrat Shadow Chancellor, Vince Cable said: "This report is little more than a watered down summary of policy changes that the Liberal Democrats have long been calling for.
"If the proposals on pay and bonuses had been followed five years ago, Britain would not be facing such a huge financial crisis now.
"However, this report completely fails to call for the separation of low risk high street banking from high risk banking. Banks should be safe places for people's savings, not huge roulette wheels.
"Banks that act like gamblers in a casino, taking massive risks for big returns, cannot be allowed to come begging to the taxpayer when things go wrong in the future."
