Paul Sharma, director of wholesale and prudential policy at the U.K. Financial Services Authority, told the annual Global ABS conference in London that risk management among financial institutions needs to “profoundly improve” if it is to satisfy regulatory bodies. In a keynote speech, Sharma said the process of improvement is already under way, but warned that regulators can only “prod and persuade companies” so far. The primary motivator for companies to overhaul risk management should be the fact they have lost money from the financial crisis, he said. He also called for greater counter-cyclical movement in capital requirements.
Sharma told the conference there was a “profoundly inadequate execution and theory” of risk management within financial services that went beyond the securitization market, but stressed it was “significantly present” within securitization. He said the strategy of using securitized debt as part of a stock of liquid assets is facing significant challenges from regulators. “Securitized assets are a poor hedge against liquidity problems which arise from a general liquidity crisis,” he noted. “The reasons why banks buy securitizations are going to come under challenge for regulatory reasons.”
Sharma said his personal opinion was that securitization still has a significant part to play in financial markets. “It will return and they have a significant and irreplaceable role in the financial system in terms of matching the needs of lenders to borrowers,” he said, but warned: “You should not assume that this is the majority view.” He pointed out that there is a question among some regulators not only of whether securitization has a future, but also about whether it can continue to play a useful role in the markets.
Sharma also used his speech to call for capital requirements to become more counter-cyclical. “The capital requirements there were on the banks tended to be, at best, neutral and at worst pro-cyclical. What we need are capital requirements that are anti-cyclical.”
He said capital requirements should act to restrain the growth of credit in boom times, but are released as markets enter recessionary periods. “This is a strongly held view in the U.K. and is becoming increasingly popular across the world,” he said, adding that details of capital requirements need greater refinement. “There is not yet an agreement at the technical level, but the need for it is receiving greater recognition.”