There will be plenty of villains when Financial Services Authority chairman Lord Turner reveals his reform of regulation later this week.
Credit-rating agencies, hedge funds, complex financial products, proprietary traders and excessive pay will all be pilloried. But it is imperative Turner reserves some blame for the watchdog he joined last September.
The FSA didn’t cause the financial crisis, but nor did it curb the banks that did. If the City needs turning inside out, the FSA requires turning upside down.
The watchdog tweaked its rules after letting Northern Rock slip through its hands. Now that bigger banks have stumbled it must rip up the rulebook and change its whole approach to regulation.
- Act like a consultant.
It has to stop thinking like an auditor and become a management consultant. Simply confirming a bank’s systems function and books balance is not enough; it must question where the bank is going.
That means testing the underlying business model, not accepting directors’ confidence it will work. Lapses at the Royal Bank of Scotland and HBoS show the FSA must not only ensure individual banks survive, but that the whole financial system can withstand a collapse.
The old remit left the Bank of England monitoring financial stability while the FSA watched individual banks. - Bare its teeth.
The FSA now needs a wider vision — so wide it risks overlapping the Bank. Better these institutions tread on each other’s toes than dance apart. - Get tough on the causes of crisis.
Turner will impose tough rules.
The City’s 2,000 proprietary traders, the dealers who bet the banks’ own money, will face fit-and-proper tests that probe their drug habits as well as their financial skills.The banks will need to find two or three times the capital backing for such activity. It’s likely to result a lot fewer prop traders and a lot less trading.
Hedge funds wanting to act like banks will find themselves regulated like banks, with capital and liquidity requirements.
Products most regulators and bankers cannot understand will be banned. Non-executive bank directors will have to be able as well as honest.
Executives may need banking experience.
Remuneration committees will be told not to incentivise bankers to gamble the bank while suffering no loss when the bet fails. That means long-term bonuses that pay only when the profit is banked.
- Make strictness a selling point.
With markets at a virtual standstill, this is a good time to impose tighter rules. Hopefully, tough UK standards will drag up international regulation.But Britain should not regret losing the institutions that choose easier berths. In the era of light-touch regulation, Turner might have feared finance houses fleeing to lax regimes, but that age is over.
He can now sell Britain as a place where tough rules protect the investor and attract business. FSA authorisation ought to be the banks’ best marketing tool.
But Turner must not quash innovation or product differentiation. Abolishing risk is not a feasible solution.
Financial history is riddled with products that looked safe in buoyant economies but turned sour when markets turned down — household mortgages, for example. It would be a mistake not to let banks make mistakes they can afford.
The FSA is lucky to get a second chance to put its own house in order when self-regulation is going out of fashion. It’s right to strengthen this watchdog rather than return responsibilities to a Bank of England — after all, it dropped the ball on Barings and BCCI.
Passing the job to and fro every time a bank fails merely opens cracks for the next disaster to fall into.
