OECD calls for tougher British financial regulation

British banks need to regulate more strongly to achieve financial stability, according to the latest economic survey by the Organisation for Economic Co-operation and Development (OECD).

Although Britain’s “distinctive” regulatory approach appeared to have some advantages in terms of innovation and development of the financial sector, the credit crisis has underlined its weakness.

The British banking sector is among the largest, most internationally open, and highly developed. However, the annual report says that some banks relied heavily on funding from the interbank market via securitisation, and have experienced large losses on holdings of asset backed securities as the financial crisis struck.

Fighting the impacts of the credit crisis has required comprehensive public intervention to support the banking system through guarantees. Injections of capital and nationalisations were also among the measures taken.

“It will therefore be important for everyone to learn the lessons of this crisis for banking regulation and supervision, particularly in areas such as liquidity, where previous policies were out of line with international practice,” the report highlights.

In the short-term, the OECD says, it is vital to restore the capacity of the banking system to supply credit. However, a well-functioning regulatory framework—that will ensure an effective and stable banking system—is essential to sustained long-term economic growth.

The OECD pressed for more resources to be allocated to supervising major institutions and gathering more supervisory information. This should be accompanied by greater engagement by senior management of the Financial Services Authority (FSA). The Bank of England would play a crucial role in enforcing the OECD’s recommendations.

So far, financial conditions remain tight despite monetary and fiscal policies, with the crisis threatening the stability of the financial system. External conditions are also highly unfavourable, the report continues.

Since the peak, Britain’s GDP has contracted by 4.2% in real terms and is projected to contract further, with an estimated decline of 4.3% in 2009. As Britain keeps fighting the financial downturn, gross government debt-to-GDP ration is expected to reach about 90% by 2010. Government deficit is widening rapidly, the OECD says, and likely to reach around 14% of GDP in 2010. Growth will remain well below trend as households and firms rebuild their balance sheets, the report continues.

Monetary and fiscal stimulus, the weaker exchange rate and some recovery in foreign demand should lead to a recovery during 2010. However, the OECD says, this will depend critically on whether measures to stabilise the financial system are effective.

“The extent of the global downturn on activity is unclear,” the OECD says.

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