Vol 8 (2011) - Issue 1

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Bank Reform in the UK: Part II – Return to the Dark Ages?

'To undo the integrated approach to risk assessment, would be to return regulation in the UK to the dark ages!' (Sants)

1. The fall of the FSA

The banking crisis played an important part in the General Election of June 2010 with the Labour government claiming it was the consequence of exogenous events and that Gordon Brown had spearheaded the international response, and opposition parties arguing that the government’s reputation for economic management was shattered because of the failure both to prevent the crisis and to respond appropriately when it occurred. A victim of the backwash from these debates was the Financial Services Authority (FSA), which was implicated because the crisis occurred under its watch and, perhaps, because it had been a keystone in the fiscal structure introduced after Labour’s victory at the 1997 election. It was claimed that transferring bank regulation from the Bank of England to the FSA meant no agency had oversight of the financial system: the Financial Services and Markets Act 2000 had not made this one of the FSA’s functions, and, as a result, it concentrated on conduct of business. The tripartite system was meant to resolve such issues by providing a conduit between the FSA, the Bank and the Treasury; but the crisis revealed a failure of coordination between these bodies, characterised by Paul Tucker, from the Bank, as a problem of 'underlap'. The strength of such claims was implicitly acknowledged in the Banking Act 2009, which gave the Bank statutory responsibility for financial stability and established the Financial Stability Committee at the Bank, although the relationship between this role and the FSA’s functions was left unclear.

George Osborne, when Shadow Chancellor of the Exchequer, concluded that a complete restructuring of the regulatory system was needed. He proposed that the FSA and the tripartite system be abolished. In their place 'a strong and powerful Bank of England' should be given responsibility – through a Financial Policy Committee – for macro-prudential and micro-prudential regulation. He argued this would 'ensure that monetary policy, financial stability and the regulation of individual institutions are closely coordinated'. The Liberal-Democrat manifesto, on the other hand, did not suggest the abolition of the FSA or the tripartite system, but instead favoured a stronger relationship between the FSA and the Bank through a Council on Financial Stability. The Coalition agreement that followed the 2010 election contained a promise which, although short on detail, resembled the Conservative proposals, Nevertheless, when the FSA’s abolition was not immediately announced, rumours circulated that there had been a compromise between the parties which meant it would survive. As it turned out, George Osborne was working on his reforms and, crucially, he was planning how to reassure the City and the international markets that they would not cause uncertainty or weaken banking regulation. A key to this in his view was the conversion of Hector Sants, chief executive of the FSA, from opponent to supporter of reform so that he would stay on through the transition and then take a leading role when regulation returned to the Bank. In addition, Lord Turner, who had been appointed chair of the FSA at the height of the crisis in September 2008 and had conducted a well-received review of the FSA’s work, was persuaded to remain in post during the transition.