Outlining the huge costs of the current financial crisis, Turner remarked: "Any benefits of the wave of complex financial innovation we have been through would have had to be very large to outweigh these costs. But it is unclear the wave of financial innovation could ever have delivered significant benefits even if it had not also created major instability... we need to recognise that not all innovation is useful".
He called for higher capital requirements, in particular new capital and liquidity regimes for banks' trading books. This, he said, "would almost certainly result in an increasing number of banks choosing to focus entirely on classic commercial banking activities; and it would help ensure that where commercial banks are significantly involved in trading and market making activities, they should and will be doing so as a means of providing necessary services to commercial customers, rather than a standalone activity".
This suggestion echoed similar recent proposals from other regulators, including the Swiss regulator Finma's Daniel Sigrist, who recommended higher capital levels as a tool to force banks to simplify their businesses in an interview with Risk in March.
Turner said that one of the factors behind the collapse of banks such as Northern Rock was a growing mismatch between the terms of bank assets and liabilities: by funding in the wholesale markets, banks were borrowing short and lending long to a far greater extent than before, leaving themselves open to liquidity risk. Regulators, meanwhile, had missed this development because their attention was elsewhere. "Bluntly, we took our eye off the ball on liquidity, while directing a huge intellectual effort to the complexity of Basel II banking book capital reform. Liquidity regulation needs to return to centre stage," Turner said.
The answer, he continued, was to push banks towards longer-term funding by "a change in the term structure of interest rates. If banks have to hold more short-term assets, and fund with somewhat longer tenor liabilities, than long-term interest rates should marginally increase relative to short term rates in order to induce the non-bank sector to hold the converse position. This slight rise in long-term interest rates would in theory be marginally less favourable to long-term investment" - a theoretical economic cost, but one which could be outweighed by the benefits of greater stability.
Demanding higher regulatory capital levels might also bring benefits as well as costs - and the costs might be offset by the lower risk of investing in a high-capital bank, which would mean a lower cost of equity capital for the bank, Turner suggested.
He also warned international banks should be prepared to face the cost of tighter national regulation - including more limits on capital in each national branch - if it would mean that the wider economy would be more stable as a result. "We need to design a banking system and credit intermediation system focused on its core and essential functions in the real economy and better able to be a shock absorber rather than itself a source of instability," Turner concluded.
See also: Never again