-- Peter Thal Larsen is a Reuters columnist. The views expressed are his own --
By Peter Thal Larsen
LONDON, June 29 (Reuters) - Should credit derivatives be treated like a new cancer drug? That's the implication of an intriguing idea from the Bank for International Settlements. In its latest annual report, the central bankers' bank suggests financial products be regulated like medicines [nLAG003542]. While superficially appealing, however, this proposal has serious flaws.
Regulators have tended to shy away from approving financial products, preferring to make sure they were transparent and only sold by qualified advisers. No longer. Britain's Financial Services Authority recently raised the prospect of capping loan-to-value ratios on new mortgages.
The BIS goes further. It suggests that, like drugs, only the safest loans and investments would be available over the counter. More complex offerings would be restricted to qualified individuals. New products would be subjected to extensive tests, like clinical trials. Those deemed too dangerous would be banned.
There are some similarities with medical regulation. Just as the sick are not expected to understand how drugs work, the average consumer is ill-equipped to understand the risks inherent in many financial products. If bad drugs are sold on a large scale, they can undermine confidence in the system. The same is true for sub-prime mortgages.
However, the analogy is far from perfect. In medicine, the similarities between humans outweigh their differences: most people suffering from a headache benefit from an aspirin. Financial health is harder to assess. Deciding whether someone should borrow five times their income to buy a house, or invest in an emerging markets bond fund, is impossible without looking at their overall financial situation.
As for conducting experimental trials, the mind boggles. Would new CDOs be tested on monkeys before being cleared for human consumption?
Given the excesses of the boom, regulators should probably have the power to ban financial products if it could be credibly shown that they posed excessive risks to consumers or the system. But a formal vetting system poses new problems. Creating a class of government-approved financial products would allow consumers to worry even less about what they are buying. It also risks perpetuating the notion that financial products must be complex in order to be effective, when the opposite is the case.
The pharmaceutical industry can legitimately claim to produce dozens of truly innovative products every year. Despite its repeated claims to the contrary, the financial services industry cannot. (Edited by David Evans)