If the cap fits

18 March 2010 By Peter Thal Larsen Follow @Peter_TL

Western policymakers agree on the need to spot and prick future financial bubbles. But as the FSA’s Adair Turner rightly points out, tweaking banks’ capital ratios will not be sufficient to prevent excesses. Regulators may also need powers to stop people from borrowing too much.

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Adair Turner, chairman of Britain's Financial Services Authority, on March 17 raised the possibility of capping the size of loans as a way of preventing future credit booms.

In a speech at CASS Business School, Turner argued that imposing such caps, such as maximum loantovalue ratios on mortgages, may be necessary to restrict the supply of credit to particular sectors of the economy.

Turner's comments come amid a growing consensus that policymakers should be given "macroprudential" policy tools to help rein in future bubbles.

In November 2009, the Bank of England published a discussion paper that recommends the creation of a "macroprudential" body that would have the power to raise the capital ratios required by banks for lending to areas of the economy it felt were in danger of overheating.

But Turner suggested this might not be sufficient. "Tools which solely address on balance sheet credit?might be undermined if over exuberant credit supply simply migrates to an offbalance sheet form. This might?imply the need to consider borrower focused restraints...rather than concentrating solely on lender focus credit supply," he said.

In particular, Turner identified commercial property as a particular source of potential economic instability. "What much [commercial real estate] lending does is to enable investors to leverage their purchase of already existing assets, enjoying as a result the tax benefit of interest deductibility, often in the expectation of mediumterm capital gain, and in some cases exploiting the put option of limited liability," he said.

Proposals for financial reform in the United States, unveiled by Senator Chris Dodd on March 15, call for the creation of a Financial Stability Oversight Council. The body would be charged with identifying and responding to emerging risks throughout the financial system, including regulating nonbank financial companies and placing increasing demands on systemically risky institutions.

Context News

Adair Turner, chairman of Britain's Financial Services Authority, on March 17 raised the possibility of capping the size of loans as a way of preventing future credit booms.

Turner's comments come amid a growing consensus that policymakers should be given "macroprudential" policy tools to help rein in future bubbles.

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