A boring policy, but worth it

SIR Howard Davies did not get to where he is today by making off-the-cuff remarks he had not thought through carefully beforehand. The chairman of the Financial Services Authority, the City's number one regulator, does not go on television and make concerned noises about the solvency of the nation's insurance companies by chance.

After being wrong-footed on Equitable Life, it is politically astute for the regulator to register publicly his awareness of the difficulties insurance companies face. If some of them get closed to new business in the future, no one can say the FSA issued no warnings. Similarly, it makes it harder for the management of troubled insurers to remain in denial.

Nevertheless, there are real problems. Standard Life, which must be one of the soundest insurers, has said it plans to raise a further £1bn and Friends Provident is touting round the City for £800m. Their regulatory returns reveal that their free asset ratios - the surplus of assets over liabilities and the surplus on their with-profits funds - have been devastated by two years of falling share prices. Most companies must be in the same boat.

The simplest solution short term is to relax the regulatory requirement - which the FSA has quietly done - because although it sounds heretical it does not matter much if the ratios are breached in the short term. A lack of solvency does not spell immediate disaster for an insurance company the way it does for a manufacturer.

What could cause huge anguish, though, is if the fall in share prices continues. This is already the longest bear market, though not the deepest, since the 1930s but some suggest there is still further to go. Applying trusted historic valuation yardsticks, the research boutique of Smithers & Co run by our columnist Andrew Smithers reckons that British shares are still 40% overvalued and US stocks have a further 58% to fall to reach fair value.

It would have a brutal effect if shares actually fell to that level, but of course the adjustment can also take place over a much longer period by shares moving sideways while the economy and profitability levels catch up. But it is slow. Between 1965 and 1982 the index of share prices did not rise at all.

If you consider such adjustments tedious for investors, think of the alternatives. If it helps the financial sector to adjust without collapse, boredom is a small price to pay.

Euro reality

IN its regular bulletins on the euro the Bank of England has often made it clear that the UK retail banking sector might need a long period of adjustment before it was ready for the single currency. But it also emphasised that this would not matter too much because the Bank itself would be ready, as would the wholesale markets on which the City depends. They are the critical bits. The rest of the economy was not under such acute time pressure.

So Wednesday's report from the British Bankers Association that they will need three years to convert does not kill the prospects of Britain joining the euro in this Parliament. If necessary, we could join before the retail banks were totally ready and wing it. Alternatively, we could have the referendum but give a two-to-three-year breathing space before entry. We do not have to leap straight in just because we have had the vote - there is scope for finessing the entry both ways.

These points will no doubt be lost as the pro and anti euro factions struggle to turn the BBA's comments to their advantage. But in fact the BBA comment takes us no further forward. The unchanged reality, surely, is that no prudent board in a financial institution will commit the necessary funds to prepare for the euro when there is such vagueness about the Government's intentions. That won't change until we have a date for the referendum.