It has been said that those who cannot learn from history are doomed to repeat it. Anyone with a knowledge of the history of financial services regulation in the UK must be listening with despair to Government statements of more regulatory powers and Conservative proposals, if they win the next general election, to move supervision of the banking sector back the Bank of England. Both the Government and Opposition continue to fail to address fundamental internal flaws in the system which have been caused, at least in part, by regulatory failures by the Government, Her Majesty’s Treasury, the Financial Services Authority and the Bank of England. The Government however, perhaps understandably, prefers to look outward blaming the system, inadequate powers and, on this occasion of failure, bankers and the banking industry as a whole.
But in spite of this denial, there is a general consensus amongst the rest of us that the regulatory system has let us all down and that public confidence needs to be restored. This will need real change not just more tinkering. And, even if deep in our hearts we know nothing will stop the next failure, we can at least hope that the changes made mean that the chances are it’s a smaller debacle than the present one. Current Government plans for more regulators and regulation won’t do it. They’ve tried that before and it hasn’t worked. And, Messrs. Cameron and Osborne clearly have to come up with a convincing plan, but moving oversight back to the Bank isn’t it either. If either side wants make a real and lasting difference they should address two key issues: competence and governance, something the current Government has failed to do and the Conservatives look like they may be tempted to repeat.
The Blair Government, with Gordon Brown as Chancellor, rightly sought immediately on taking power in 1997 to improve banking supervision, which had seen a number of serious failures during the 1990s such as BCCI and Barings. However, their efforts were weakened because they failed to get to the very roots of the problem. As we are hearing now, there was a belief that it was the system and the law that were wrong and a jolly good shake up would set things right. So, we had our shake up: all the alphabet soup of the regulatory bodies forged into one and the building of a massive regulatory system with support from the biggest piece of legislation ever to go through Parliament,
The trouble was they didn’t change the people. It was not just about inadequate laws or regulatory powers (as regulators claimed then as now) that brought regulatory failures, but the people running the system. They didn’t all do their job properly, many did but not all. So, in spite of all the effort and in a classic piece of British muddle the Government failed to apportion responsibility to those that brought the failures, to review where there had been shortcomings and, most importantly, to stress the competences and suitability of the individuals. Instead, the responsibility for banking supervision, when transferred to the newly-formed FSA, was accompanied by many of the senior executives and middle ranking managers from the Bank which were then given similar or more senior jobs at the new regulator. As a consequence, the competences, skills and philosophies which had proved to be major weaknesses in banking supervision were thus transferred at a stroke three miles up the road to a new building with increased powers and a much wider remit, but alas with no more ability. Sadly, recent events have shown that time has done nothing to improve the situation.
There is now a chance to put this right. There has been the expected plethora of calls from politicians for additional regulation in the UK, Europe and even globally. And, the Conservative plan to transfer powers back to the Bank threatens to turn the system upside down again: they would be well advised to consider carefully history before proceeding any further as this would be a useless and even potentially calamitous action. There is likely to be no difference between FSA and the Bank of England in oversight of the banking system. The name of the organisation is immaterial. The powers and resources exercised by the regulator – be it FSA or the Bank – are fully adequate. To transfer them back to the Bank now (accompanied by the same staff, as where otherwise will you find a couple of thousand spare regulators?) will achieve nothing except incur higher costs for the industry ultimately paid for by investors and to set another time bomb ticking away because the fundamental issues remain unaddressed.
So, as a first step what is needed is an ongoing assessment of the competences of FSA staff, a meritocratic policy of employing a wider range of skills and ability, and a move away from the audit-based and risk-averse approach to which the current Government is so erroneously wed in all its regulation – financial services or otherwise. Firms regulated by FSA are required to demonstrate that their staff are fully qualified to carry out their roles. This same test, in full transparency, needs to be measured appropriately against all FSA staff and the tasks they carry out. Lord Turner in his March 2009 review appears to agree that FSA supervision needs to change and that there should be “investments in specialist skills (e.g. in the analysis of liquidity risks)”.
This should be implemented quickly and robustly, enshrined in FSA employment practices and, most importantly, demonstrated to the regulated community and wider public so confidence can be restored.
Second, the governance of the FSA needs radical change. HM Treasury and the Government are far too close to the appointment of the FSA board and ongoing oversight. HMT (and therefore its head the Chancellor of the Exchequer) has powers under the current legislation to approve the appointment and removal of the FSA chairman and all other FSA board members. FSA board appointments are subject not only to the final approval of HMT (and the Chancellor), but subtly also in the selection process as it’s no good putting people forward that HMT (and the Chancellor) won’t ultimately approve is it? Although HMT’s part in this (and its subsequent oversight) purports to be a balancing mechanism it is in reality a damaging and irresolvable conflict. There is a temptation to appoint insiders and people who will be comfortable with HMT thinking and processes. Perhaps, when the going gets tough, people who can be relied on to act with the best interests of the UK economy and business in mind. And in boom times it is not only business that benefits from a lively business environment. HMT reaps more taxes and the government of the day is able to bask in the reflected warmth of a successful economy. Regulators that want to act robustly are usually accused by business, of stifling innovation, endangering the City and being generally gloomy. Governments and treasuries which rely on business taxes and a healthy trading environment are always courted by business which seeks to tamper, and sometimes actually impede, regulation. We didn’t hear many calls from either the Government or the Opposition for more regulation in the boom and before the collapse of Northern Rock: there were even calls for less regulation of the mortgage market from some political quarters. And even if we don’t want to believe the recent allegations from some regulators and compliance officers of how they were ignored or sacked because they thought there was trouble looming, even the public perception of this conflict existing is unacceptable. This situation is not sustainable in an environment which calls for transparency and freedom from conflict. Financial regulation, like monetary policy, should be wholly independent of partisan political power and big business. Ironically, FSA would not allow this type of conflict in any firm it regulates and, to any fair minded person, it goes against the spirit of accepted guidance on governance on which FSA so heavily relies. FSA appointments and oversight should be taken away completely from HMT (and the Chancellor) and given to a new independent authority free of all conflict or direct political interest. (It might as a first task also look at why the FSA has the powers both to levy fees from the authorised community and make a judgment as to whether the fees are fair, equitable and justifiable). This independent oversight will enable regulators to act freely and without looking over their shoulders – managed properly, the whole system could also be cheaper once they are allowed get on with the job unchecked by political intervention. On taking power in 1997, the New Labour Government immediately gave independence to the Bank of England – at least in terms of monetary policy if not patronage and oversight. The present Administration in its current reforms should give complete independence to the FSA. If it fails to do so whosoever forms the next government should consider this a priority.
Until these two fundamental changes are made, these fault lines, which have in part cost the regulated community and taxpayers generally billions of pounds, will continue to undermine the financial regulatory system. Recent statements from the Government seem to focus on the same old solutions of more powers, yet another committee and new legislation: we are told to expect a new banking act before the general election. However, we are shown little, if any, new thinking and we should not expect any radical moves this side of a general election. But, a new government will have the opportunity to change the regulatory landscape to the benefit of investors and regulated firms. We must wait and see if they take it: if they don’t watch out for more of the same in a few years.