By Christina Fincher
LONDON (Reuters) - Regulators need more tools to prevent the build-up of risks in the financial system but it would be unrealistic to think all asset bubbles can be prevented, according to a Bank of England paper.
The discussion paper, written by a variety of senior figures at the Bank, says macroprudential policy instruments are an important "missing ingredient" from the current policymaking toolkit -- and one that could have eased the pain of the current crisis.
But while such instruments could help smooth the supply of credit over economic cycles, the paper suggests they may be less effective in dealing with the demand side of the equation.
"By moderating exuberant increases in the supply of credit, macroprudential policy might sometimes help contain asset bubbles. But it would be unrealistic to make the prevention of asset bubbles a specific objective of the regulation of the banking system," it said.
Britain's central bank is set to have a greater role in bank regulation if, as looks likely, the Conservative Party wins the next general election, expected in May.
The Conservatives say the financial crisis has highlighted the failings of the current regulatory framework and have pledged to hand the bank supervisory duties currently undertaken by the Financial Services Authority back to the central bank.
The Bank's paper does not reach definitive answers but makes suggestions on how macroprudential instruments might be designed in a bid to spur further debate.
It makes the distinction between tools to manage "aggregate risk" -- the tendency for banks to become overly risk-seeking in an upswing and risk-averse in a downswing -- and "network risk," the failure of individual firms to realise the spillover effects of their actions.
It examines whether a regime of capital surcharges could be introduced which could lean against the wind in the upswing and be relaxed in a downturn.
"These ideas could usefully be debated alongside existing international initiatives to dampen procyclicality in regulatory minimum requirements," it says.
To mitigate network risk, it suggests capital surcharges be set according to the systemic risk posed by an individual institution -- similar to proposals already put forward by the FSA -- thereby, providing incentives for firms to adopt less risky strategies.
For details, click on http://www.bankofengland.co.uk/
(Editing by Ron Askew)
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