In his final Mansion House speech as FSA chairman Lord Turner has said the regulator had to be "brutally honest about its own failures" on the banking crisis.
Making his fourth speech as FSA chairman, he admitted that prior to the banking crisis there were, "deficient rules, deficient structure, and dangerous culture."
He said: "The rules on bank capital and liquidity were woefully deficient – an entire global banking system allowed to run with equity capital resources and liquidity buffers which we now believe were a small fraction of safe levels. And that didn't just happen in the eight years of the FSA's pre- crisis existence; it reflected a several decades long policy error which allowed the banking system to transition to excessive leverage and inadequate liquidity."
Facing up to regulatory failures he said: "A lot of apparently very clever people got it very wrong, and the ordinary citizen suffered. We have to do better in future."
He said arriving at the FSA in 2008 felt like being the captain of the Titanic after it hit the iceberg but before it went down.
In a wide ranging speech he covered the roots of the crisis, the failure of regulation of the banks, the current Eurozone crisis, the future of regulation and, amid the gloom, some positive comments about City firms and what they had to offer the world.
In terms of the roots of the problems he said: "It is...important here at the Mansion House in the centre of the City of London to be clear that the roots of the crisis lay in one particular subset of financial services – in banks and shadow banks – in that specific part of the financial system which, if we do not regulate well, is capable of creating credit booms and excessive leverage."

But he added that the failure of banking regulation should not tarnish the good international reputation of many successful parts of the City such as, "equity research and distribution, asset management services, the wholesale insurance market of Lloyds and related companies, commodities trading" and other areas.

Full text of Lord Turner's speech: This is my fourth speech at this annual dinner and will be the last speech here by any FSA Chairman. Sometime in spring next year the new regulatory regime will be in place. So I want to reflect this evening both on the last four years, and on the FSA since its creation in 1999, but also on the financial services industry over those last 13 years.
My time at the FSA started amid crisis. I became Chairman on Saturday 20 September 2008: the previous Monday, Lehmans had collapsed, on Tuesday AIG, on Wednesday the HBOS/Lloyds Bank merger had been announced. The following week the Icelandic banks collapsed, then Bradford & Bingley, and within three weeks we had part nationalised RBS and HBOS to prevent their catastrophic failure. It felt like being appointed captain of the Titanic after we'd hit the iceberg but before we'd actually sunk.
Autumn 2008 was dominated by emergency response to the crisis: the subsequent three and a half years by radical change to address the failures that had led to it – changes in global rules, in supervisory approach, and in the FSA's structure – all amid continued threats to financial stability, and continued recession throughout the developed economies. The contrast with the FSA's first eight years – from 1999 till the first signs of emerging crisis in summer 2007 – could hardly be greater.
• In economic terms, the noughties till 2007 seemed what Mervyn King described as the NICE period – 'non inflationary consistently expansionary', and political debates were more about how to spend the fruits of growth than about threats to its continuation.
• And as for financial stability, those eight years seemed years of plain sailing and calm seas, with risk indicators such as bank Credit Default Swap spreads reaching their lowest ever level in spring 2007; and with debates about regulation more focused on fostering London's competitiveness through 'light touch' regulation, than on any concern that poor regulation might be creating the conditions for future crisis.

In retrospect, it was a fool's paradise – the band playing on oblivious to the dangers ahead.
Causes of the crisis
The crisis seemed like a bolt from the blue: but obviously it wasn't – it didn't just happen – it happened because of multiple failures in policy and practice. And it's essential to identify those failures, and put them right for the future. The FSA has been brutally honest about its own failures.
• In April 2008, we published our internal audit report on Northern Rock, sharply criticising the supervisory failures which allowed Northern Rock to pursue highly risky expansion.
• In March 2009, my own Review identified severe deficiencies in UK and global banking regulation.
• In December 2011, our report on RBS, described in detail a pre- crisis approach to supervision which was insufficiently focused on capital, liquidity and asset quality – the trinity which should be at the core of good prudential supervision.
In its supervision of banks the FSA made huge mistakes: and has acknowledged them – and changed radically in response. But it's important to place FSA supervisory failures in context, because if we tried to fix the problems of the past simply by supervising more intensely and better, we would fail to ensure a more stable system. Because still more important than poor supervisory approach were deficient rules, deficient structure, and dangerous culture.

The rules on bank capital and liquidity were woefully deficient – an entire global banking system allowed to run with equity capital resources and liquidity buffers which we now believe were a small fraction of safe levels. And that didn't just happen in the eight years of the FSA's pre- crisis existence; it reflected a several decades long policy error which allowed the banking system to transition to excessive leverage and inadequate liquidity. And the structure of the UK regulatory system was wrong in two important ways:
• First, because the FSA was asked to do too much, combining in one organisation functions best kept separate. Good prudential and good conduct supervision require different skills and approaches. Combine them in one organisation, and there is a danger – which became reality in the FSA – of divided top management attention and an insufficiently differentiated approach.
• Second, because the pre-crisis structure left a gaping underlap between the Bank of England responsible for monetary policy and the FSA for the regulation of individual firms, with neither adequately focused on the systemic risks created by system-wide increases in leverage, by booming credit supply and asset prices, by the development of shadow banking, and with neither equipped with the macroprudential tools which could offset them.
And finally culture – dangerous culture within major banks.
• Cultures too driven by short-term return, and inadequately focused on long-term risks.
• Too focused on sales and not enough on customer value.
• And with bank leadership continually seeking opportunities to increase leverage, generating higher returns for shareholders in the upswing, but increasing the danger that tax payers would end up bailing them out when the dance came to a halt.

Bankers forgetting or choosing to ignore the fact – as did policy makers – that banks are different, that unlike retailers, or manufacturers, or hoteliers, their failure can have consequences for the whole economy not just their shareholders, and that we therefore need bank boards and management to strike a different balance between risk and return than is appropriate in other sectors of the economy.
So the crisis was not a bolt from the blue – it arose from poor supervision, from bad rules and structures, from dangerous cultures – and the errors were made by regulators, economists, central bankers and public policy makers, as well as bankers themselves. A lot of apparently very clever people got it very wrong, and the ordinary citizen suffered. We have to do better in future.
Putting it right
Many of the required policy responses are already in hand, in the UK and internationally.
In the UK, the structural changes which will take statutory form next spring will enable better focus, and close the past dangerous underlap between monetary policy and prudential regulation. Separating responsibility for prudential and conduct supervision is I am sure the right way to go and will support further progress of reforms already in hand.
• Within the FSA we have already made major changes to prudential supervision – more focussed on the fundamentals of capital, liquidity and asset quality, and more effective now that we have prudential supervision separated in the Prudential Business Unit which Andrew Bailey leads. These reforms will be intensified as we create the Prudential Regulation Authority within the Bank of England.
• In conduct supervision too the FSA is developing a more effective and robust approach, and is better able to do so now that conduct supervision is the focused responsibility of the Conduct Business Unit under Martin Wheatley which will become the Financial Conduct Authority.
• And the creation of the Financial Policy Committee (FPC), already operating in shadow form, is a vital step forward. A body responsible for identifying risks across the whole banking and wider financial system, and equipped with macro-prudential tools such as countercyclical capital requirements which can lean against excessive growth of credit and leverage. And to be given by Parliament, alongside its primary objective of financial stability, the secondary but very important objective of supporting as best possible growth and employment – a clear indication that in pursuing financial stability we should not be satisfied with what the Chancellor described here at the Mansion House in June as 'the stability of the graveyard'.

Global and European rules on bank capital liquidity have also been transformed, with the FSA and the Bank together playing a leading role in the analysis, debates, and, it felt at times almost endless, negotiations which resulted in the Basel III regime. That regime will ensure a far sounder future banking system, correcting the errors of the past several decades. And we are now debating, in the international Financial Stability Board, the details of major reforms to counter the risks created by the complex network of institutions and activities which we label shadow banking, and by the enormous web of over-the-counter derivative contracts – a reform package which we will present for endorsement by G20 leaders in November.
Equally important are the structural reforms to the banking system recommended by the Vickers' Commission. By creating ring-fenced retail banks, and by demanding adequate levels of bail-inable debt, these reforms will help ensure that all banks can be resolved rapidly without tax payers' support and without harmful disruption of banking services to the real economy.
And as for culture, there are increasing signs that many banking industry leaders recognise the need for major change, change which we as regulators can encourage through our regulation of compensation practice, and through being clear that poor conduct is not acceptable.
So the crisis was a massive one, but the policy response has also been rapid and extensive.
And I am confident that this programme of reform will result in a future banking and financial system less likely to wreck the havoc in the real economy which our past failed system did in 2008, and better equipped to play its vital roles in serving the needs of the real economy.
Managing the transition amid deflationary threats
But the challenge is not simply to build a better system for the medium or long-term future, but to transition to it while not harming recovery from the Great Recession which the crisis of 2008 induced. And managing the transition is more difficult than defining a better end point. In all the economies of the developed world – in the US, Japan, the Eurozone and the UK – recovery from recession has been far slower than most commentators and all official forecasts anticipated in 2009. And that reflects the two major intellectual and policy failures of the pre- crisis period.
• A failure to understand just how powerful are the deflationary effects created by deleveraging in the aftermath of financial crises, and therefore how important it is to prevent the development of excessive leverage in the first place.
• And the flawed design of the Eurozone project, launched without a commitment to a banking union, and without some fiscal integration, which it is now clear, are both essential to its success.
The crisis was created by a boom in debt, in leverage, and in complexity, and initially by developments in the private sector and within finance itself, rather than by profligate governments. Private debt levels grew rapidly relative to GDP or household income in many countries – in the US, the UK, Spain and Ireland. Leverage within the financial system grew dramatically throughout the developed world – both transparently on bank balance sheets and in hidden non-bank and shadow bank forms. And intra-financial system complexity hugely increased – securitisation, credit structuring and derivatives, combining to create a complex web of links within the financial system which greatly increased its vulnerability to shocks.

The dangers created by those developments are now crystal clear. But sadly they were not clear to most economic experts and policy authorities before the crisis. Indeed the dominant wisdom of the time was that developments in financial markets, and increases in leverage, whether within the real economy or in the financial system, could either be ignored or positively welcomed.
As the current IMF Chief Economist, Olivier Blanchard, commented last week, 'we assumed we could ignore the details of the financial system'. Or as Mervyn King put it in his lecture at the London School of Economics this Tuesday, the dominant school of modern monetary policy theory – the New Keynesian model as it is called – 'lacks an account of financial intermediation, so money, credit and banking play no meaningful role'. As for the IMF before the crisis, it confidently asserted in April 2006 that there was 'growing recognition' that financial innovation had 'helped make the banking and overall financial system more resilient' and that this resilience could be seen 'in fewer bank failures and more consistent credit provision. Consequently the commercial banks may be less vulnerable today to credit or economic shocks'.
The dominant assumption was that monetary stability – low and stable inflation – was sufficient in itself to ensure financial and macroeconomic stability, and that the public authorities did not have to pay attention to financial innovation, increased financial complexity or increased levels of debt and leverage. That assumption turned out to be profoundly wrong and dangerous, a major intellectual failure.
Policies based on that intellectual failure led to the crisis of 2008. And that crisis has left us in a hugely difficult position. Because in the aftermath of an excess leverage boom, attempts to deleverage – to restore private sector balance sheets, to pay down mortgages, to avoid new debt commitments – themselves depress spending and economic activity, making it more difficult actually to reduce leverage levels. And post-crisis recessions have played havoc with public finances, increasing fiscal deficits, so that for many years after the crisis, overall economy leverage doesn't reduce at all, but simply shifts from the private to public sector. That's the pattern we saw in Japan after the credit boom of the 1980s and bust in 1990. That's what we've seen over the last four years in the US, in Spain, and in the UK.

And in this environment, our ability to offset deflationary effects via the classic tool of monetary policy is limited because interest rates are already close to the zero bound: and because the transmission of low policy rates to the real economy is hindered by banking system fragility and deleveraging, undermining credit supply. And because our freedom to use fiscal stimulus is limited by the need to get rising public debt burdens under control.
Post-crisis deleveraging is very, very difficult to manage: that's what the economic history of Japan from 1990 to today demonstrates – and that's the lesson policy makers and economists have increasingly learned in the last three years. And if we do not carefully design policy in response, the deflationary impact on economic growth could extend for many years ahead. As the IMF noted this week, when it published its latest downward revisions of global growth projections, 'risks of recession in the advanced economies are alarmingly high'.
The policy response has to include, and has included, unconventional monetary policies – quantitative easing – which as best we can tell has produced a path of real output growth and inflation slightly higher than would otherwise have occurred.


But quantitative easing alone may be subject to declining marginal impact, the economy facing a liquidity trap in which replacing private sector holdings of bonds with private sector holdings of money has little impact on behaviour and thus on demand. So optimal policy also needs to include a willingness to employ still more innovative and unconventional policies, and to consider the combined impact of multiple policy levers – monetary policy, Bank of England liquidity insurance, prudential regulation and direct support to real economy lending – which we used either to consider quite separately, or else avoid entirely. That integrated approach lay behind the recommendations which the FPC made in June.
For the last year, the FPC has been struggling with a trade-off – and I suspect our communication might have been clearer if we had been more explicit about how difficult that trade off is.
We want to make our banks more resilient to future shocks, and in the medium term that will be good for credit supply to the real economy – if markets lack confidence in bank resilience they will only fund them at high rates which feed through to high priced and restricted credit. And greater resilience requires further progress towards the adequate capital ratios we didn't have in place before the crisis.
But if we simply demand higher capital ratios, and if banks achieve them via deleveraging, that would be bad for credit supply and bad for economic growth. So we face at least a potential short-term trade off between resilience and lending. Ideally we wouldn't start from here – we would have insisted that capital and liquidity buffers were built up during the boom years – both slowing the boom down and allowing us now to release those buffers, to help maintain real economy credit. But saying we ideally wouldn't start from here isn't good enough. We have to find creative ways forward which as best possible both increase resilience and support lending and as a result, maintain nominal demand. That was the aim of the package of measures announced in June.
• The Bank of England providing greater liquidity insurance through the activation of the Extended Collateral Term Repo facility, and the FSA adjusting our bank liquidity guidance to reflect greater central bank insurance, and to make it easier for banks to use their liquidity buffers when needed.
• And the Bank of England launching the Funding for Lending Scheme to support new bank lending to the UK economy, while at the FSA we have made adjustments to our capital regime to allow additional FLS lending to be supported by capital buffers already in place – with no additional incremental capital requirement – action which will help remove a potential impediment to use of the scheme.
This is an innovative combination of policies, and one which lies far outside past orthodoxy. And we need to be ready if these measures prove insufficient, to consider further policy innovations, and further integration of different aspects of policy – to overcome the powerful economic headwinds created by deleveraging across the developed world economies.
Those headwinds would be severe enough even if all we faced – across the developed economies – was post-crisis deleveraging. But the way forward is further complicated by the crisis in the Eurozone. Ten years ago I argued in favour of the Eurozone project and for Britain's eventual membership. As I have said before, I was wrong, failing to recognise the inherent flaws in the Eurozone's current design. And it's important for both individuals and institutions to recognise mistakes and learn from them.

The crucial mistake was a failure to recognise that debt issued by a nation within a multinational currency zone is quite different from debt issued by a nation which also issues its own currency – it is inherently more susceptible to default risk, it is inherently less likely to be perceived as risk-free. As a result, in a multi national currency zone with significant debt issued at national level, bank solvency and national solvency can become linked in a potentially fatal embrace. If within the US single currency zone someone suggested that banks based in, say, Illinois should hold as their risk-free liquid assets, undiversified portfolios of Illinois State bonds, the idea would be dismissed as absurd, a perfect way to create wrong way, correlated risk. But that is what we have done in Spain, in Ireland and Italy – with the perceived solvency of banks pulled down by fears for state solvency; and with state solvency either already undermined by public bank bail-outs, or by fears that bank bail- outs will be needed in future.
Failing to see those dangers in advance was the second big intellectual failure of the pre-crisis period. And because of that failure, we are now faced, across the vulnerable peripheral Eurozone countries, with a dangerous combination: impaired banking systems unable adequately to support lending and demand growth; and governments attempting dramatic fiscal consolidation in order to control rising public debt burdens, fiscal consolidation which further strengthens the deflationary headwinds.
If the Eurozone is to succeed it will have to pursue what George Osborne described last July as the 'remorseless logic of integration', with a common fiscal back stop for banks that cannot be resolved without tax payer support, with mutual deposit insurance, with banking supervision centralised under the authority of the European Central Bank, and with some category of joint Eurobonds emerging as the undoubted risk-free asset. In other words, what has come to be labelled a 'Banking Union', plus some fiscal integration. Without such union and integration the Eurozone cannot survive.
The UK, while remaining within the European single market, does not need to, and will not, be part of that Eurozone Banking Union. But we have an enormous national self-interest in the Eurozone either taking the steps required to succeed, or, if that is politically unattainable, dissolving in a controlled rather than chaotic fashion. We need to use what limited influence we have to help achieve the best possible way forward.

Conclusion
My Lord Mayor, ladies and gentlemen, I began by referring to the 13 years of the FSA's existence – the first eight seemed plain sailing, the ocean, iceberg free. But that was a delusion, the vulnerabilities relentlessly growing, but we didn't spot them. As the crisis broke in 2007 to 2008, there was much criticism in Continental Europe of the excesses of 'Anglo-Saxon' finance – and a belief that the disaster had been created by excessive private leverage, by too light regulation, and over-complex financial innovation, and by a mistaken intellectual assumption that whatever the private financial system did, it must in some indirect way be contributing to financial stability and growth.
Later, after 2010, as the Eurozone crisis grew, many commentators particularly in Britain and the US, stressed instead the inherent flaws of the current Eurozone project, its fault lines created by a triumph of political aspiration over attention to economic risks. Well, both criticisms were right. And as a result we are in an extremely difficult position. When banking is badly regulated, crisis follows. When excess credit growth leads to bust and subsequent deleveraging, the headwinds to economic growth are very strong: when in addition we are struggling with an ill-designed Eurozone, they are more severe still.
We need to build a sounder banking system for the future, and many of the reforms needed to achieve that are already in hand. But we also need to ensure that the stability we build is not the stability of the graveyard. The new structures which will be fully in place by next spring – and in particular the role of the FPC – are well designed, but we will need to use them well – and to be open to further policy innovations – if we are to overcome the deflationary headwinds we face. And we will need to support from outside and influence as best we can the redesign of the Eurozone, to ensure that our domestic efforts are not undermined by headwinds from abroad.
My Lord Mayor, I fear my remarks this evening will not have left us all in great cheer – but I cannot apologise for that – the challenges ahead are great, and if I had not talked this evening about the aftermath of the 2008 banking crisis, the slow pace of economic recovery, and the crisis in the Eurozone, I would rightly have been accused of ignoring several large elephants in the room.
But it is also important here at the Mansion House in the centre of the City of London to be clear that the roots of the crisis lay in one particular subset of financial services – in banks and shadow banks – in that specific part of the financial system which, if we do not regulate well, is capable of creating credit booms and excessive leverage. But there are many other parts of our financial system, of the City, which played no role in the origins of the financial crisis, and which have continued to provide important high quality services to the world economy throughout the last five years – equity research and distribution, asset management services, the wholesale insurance market of Lloyds and related companies, commodities trading – and it is essential that as we fix the problems of the banking system, we also celebrate the success of many other City services and firms. And that indeed is a crucial part of your role, my Lord Mayor, representing the City in Britain and across the world. It's one you have played with great energy and effectiveness over the last year.
So I invite you all to rise and join me in the traditional toast of good health and prosperity to 'the Lord Mayor and the Lady Mayoress'.