Why regulation is needed as our financial system has shown - Andy Brown

Regulating sewage disposal is also rather important. It is being pumped into our rivers on thousands of occasions each year because the enforcement of regulations is so weak. The rules are very clear that it is not legal to do this except in very exceptional weather. What is missing is enough staff in the Environment Agency to inspect and to enforce the rules.

Yet the scale of economic damage caused in these cases pales into insignificance when it is compared to the harm caused by weak regulations of banks and financial traders. The 2008 financial crash was almost entirely caused by deregulation of the City of London, enabling highly profitable behaviour for individuals which put at risk the entire financial system.

Most of the pain caused by that problem was not inflicted on those who caused it. The traders who took the risks kept the profits and the bonuses that they received from successful gambles. It was governments and ordinary people who paid the price of the bets that failed.

Much of the huge debts that governments currently carry can be directly traced to the bail outs they had to provide to avoid a complete failure of the financial system in 2008. Years of real terms pay cuts for doctors, nurses, teachers and train drivers followed that crash.

Now we are facing another series of financial panics. Something which can seem remote and of little relevance to the lives of most of us. Until the enormity of what governments and central banks have to do to avoid a run on the banking system begins to hit us all in the pocket. Which it will.

Banking is an intrinsically risky business. If all your bank does is to leave your money safe and sound in its computer memories then it runs up costs without getting anything back and it would have to charge you a hefty bill for putting your money with them.

The only way any bank can make money is by relying on the fact that in normal times not everyone will want to draw out their cash on the same day and so they can lend out some of it and earn interest.

The more they lend out and the riskier those loans are the bigger their incomes and the better their bonuses. Which is fine until a few too many of those loans fail or their customers start to worry about whether their cash is safe.

Even the soundest bank with a high proportion of reserves can’t survive if an unusually large proportion of their customers start to panic and demand their money back.

In a badly regulated financial market too many loans are not made to reliable businesses who can be trusted to pay back. They are made in incredibly complicated ways that enable risks to be taken that regulators can’t easily control. There is a constant battle between the temptation for financial companies to make money by lending at high risk but at high rates of interest and the skill of regulators in forcing them to act with more care.

All it took to set off the latest panic was one middle sized American bank lending too much money to risky high tech companies and not factoring in the possibility that worldwide interest rates would rise rapidly. Once that bank proved to be a pack of cards people started to worry that others might also be at risk and speculators started selling off shares.

Those speculative sales can swamp action taken by central banks and governments to try and steady markets. It isn’t long before companies that were previously financially sound begin to experience their own problems and it only takes a rumour of that to spread contagion.

At a time of high inflation it is not possible for central banks to respond by simply printing and supplying free money. Which is what quantitative easing effectively did last time round. Nor is it wise for central banks to simply bail out banks that have taken risks. That incentivises bad behaviour.

At best we now face the prospect of some banks going to the wall and others being much more careful about who they lend to. If the company you work for can’t borrow enough money to expand then that will have an impact on your career. If the majority of the companies in the economy can’t expand it will cause a rise in unemployment.

At worst the system goes into a tailspin and we experience something worse than the 1930s great depression.

Andy Brown is a Craven District Councillor representing Aire Valley with Lothersdale and the North Yorkshire Councillor for Aire Valley.