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The present arrangements for the prudential supervision and regulation of British banks stem directly from the Banking Act 1979. This, in turn, was a response to growing pressures throughout the late 1970s for a more formal system of prudential regulation than had existed up to that time. As we saw in Chapter 1, these pressures sprang from two sets of factors: first, factors of philosophy or policy and secondly, the course of practical events which threw the requirements of philosophy and politics into sharper focus. The events included the secondary banking crisis of 1973–5, the uncertainties, and losses incurred, in the foreign exchange markets following the free floating of exchange rates in 1973 and the problems of recycling oil money internationally following the major increase in the price of oil in 1973.

The events of 1974 were a crisis in the everyday sense of causing great danger for banking, but they were also critical in a more exactly clinical way: they marked a moment of fevered change after which the condition of the system was irreversibly altered. The immediate effects were cathartic: individuals, institutions and practices were purged from financial life. The effects in the longer term were immensely complicated. By destroying part of the banking system the crisis weakened the customary assumptions on which prudential regulation rested. Yet to alter the rules was to change more than the technicalities of financial surveillance. Banking regulation and banking politics were entwined. Devising new methods of control appropriate to the growing scale and complexity of financial markets opened banking to influences customarily thought undesirable: Whitehall, Westminister, the courts. The major theme in regulation since 1974 concerns the problem of choosing between new means of regulation and preserving esoteric politics.

The rescue of Johnson Matthey Bankers (JMB) in October 1984 raises important issues for the prudential regulation and supervision of banks in the UK. The authorities responded to the event by proposing amendments to the supervisory system, but it is argued here that they are not sufficient to ensure that a repeat of a JMB-style rescue is avoided, nor do they deal adequately with a wider set of prudential issues that exists independently of the JMB case.

A dynamic provisioning system is one of the instruments that regulators could use for introducing counter-cyclicality into prudential regulation. The potential effectiveness of such instrument depends on how far actual backward-looking provisioning practices exacerbate growth in bank lending. We therefore investigate whether backward-looking provisioning practices amplify growth in bank lending and, if such an effect exists, whether there are differences in its magnitude across countries. Our results show that backward backward-looking provisioning systems exacerbate banks' lending fluctuations in both developed and emerging countries, but with a stronger impact for emerging countries. These results support the idea that countercyclical tools based on capital buffers might not be sufficient to dampen the cyclicality of bank lending, especially in emerging countries, and the implementation of a forward-looking provisioning system might be an important mandate.