The chairman of the Financial Services Authority today warned banks to expect an era of lower profits as he moved to clamp down on excessive risk-taking.

Lord Turner said banks may be forced to hold more than three times as much capital for their trading activities than under current rules. That will severely curb the kind of excessive risk-taking banks have been used to taking by using debt to make bets on the markets.

He said: “There is a strong prima facie case that minimum bank capital requirements should in future be significantly above those which have applied in the past.”

In a report that initially triggered a sell-off of bank shares, he added: “The future world of banking probably will and should be one of lower average return on equity but significantly lower risk to shareholders as well as to depositors. Banks should build up their reserves in the boom times, creating a buffer for when the economy sours.”

Talking of an end to “light-touch regulation” and heralding an era of “intense supervision”, Turner proposed “a revolution” in UK banking to stop a repeat of the turmoil which is crippling the economy. But he insisted his proposals pose no threat to the future prosperity of London as a leading global financial centre.

“The global financial system has suffered the worst crisis for at least 70 years, indeed the worst global financial crisis since the development of modern capitalism,” he said.

Turner blamed the rapid growth in lending, the “alphabet soup” of complex financial investments “of minimum social value” and excessive risk-taking by banks to boost profits.

Banks should be “a shock absorber in the economy not a shock amplifier”, he said. The review, published a week after FSA chief executive Hector Sants warned “people should be very frightened of the FSA”, looks set to have far-reaching consequences for banks and their business models . Turner pulled back from recommending a separation of retail banking from investment banking or, in his words “casino banking”.

Instead, he said regulators must ensure the Government guarantees enjoyed by banks should not be used to support “adventures in risky trading activities of little social value”.

Reaction to the Turner Review

John Cridland, deputy director general of the CBI

“Turner has come up with targeted proposals that deal with specific failings and a risk to the system as a whole, rather than responding to the wilder calls for action against banks.
His dispassionate, forensic approach has much to recommend it.

“We are cautious about the review's proposals on liquidity and product regulation. Rushing ahead with requirements for bank liquidity could put the UK out of step with other countries and force firms to manage their reserves on a country by country basis which would be a blow to the UK's competititiveness."

Bob Penn, partner in financial services at law firm Allen and Overy

“This is a pretty sensible set of suggestions. Some will be quite controversial, especially the ideas about product regulation and the idea of a maximum loan-to-value requirement on mortgages. That would be a massive step away from the FSA's historic approach, and would be the beginning of nanny state' style intervention in bank models. It would be very unwelcome.

“The detail on capital requirements for banks is also controversial. There's no case to support the suggestion that banks should have a leverage ratio. I don't think the talk about a core funding ratio for banks will play well in the international environment that banks operate in.

“But otherwise this report is good news for the City. At a time when we're coming up to the G20 forum, this is a timely reminder that as well as having been part of the problem, the FSA can be part of the solution to fix the financial services industry.”

Simon Morris, partner in financial services expert at law firm CMS Cameron McKenna LLP

“Turner is building on the current regulatory structure, offering sensible extensions rather than dramatic developments. The whole report is pragmatic and achievable, which will be very encouraging to the City. He's calling for more international co-ordination, saying that we do not need a stronger European regulator but better co-ordination. Turner thinks what we have is fundamentally adequate and I think he's right.

“We're going to see a general damping down of banking activity. The report suggests that banks will have to have more capital to fund their activities - they will have to store it up like an animal in winter - and regulators will look at the quality of capital, its liquidity. In consequence, there will be less lending and that will affect all commercial activity. The party is over and the Turner report is a contributory step towards the hangover cure.”

To see the Turner Review click here