Vol 9 (2012) - Issue 1

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The Reformed ‘Fit and Proper’ Test: A Call for a Broader Rethink of Bank Corporate Governance?

I. Introduction

The recent financial crisis has been followed by a series of regulatory changes concerning both the substance and the structure of financial regulation in the UK and internationally. The move to a new capital adequacy standard under Basel III, the prospective redesigning of regulatory bodies and the new banking resolution regime have all gained much publicity, and the same happened with proposals to ring fence retail banking, to split retail and investment banking, and to break-up large systemic banks. Much less attention, however, has been paid to the recent reform of the ‘fit and proper’ test and to the new regulatory approach to it, as advocated by the FSA.

This change is less spectacular than others, but can make a great difference in the way banks are governed. If the new approach is taken seriously by the regulators, it may also challenge the fundamental concepts on which the current bank corporate governance paradigm is based, thus building a case for a wider reconsideration of bank corporate governance rules and norms, including banks’ corporate objective. Of course, it is too early to say whether such a change is taking place, especially as the test operates in a confidential way so as not to harm the reputation of involved firms. Still, it is clear that the regulatory approach to the test has shifted towards closer scrutiny of prospective bank directors’ substantial merits. Indeed, the more detailed approval procedure is a further example of the gradual juridification of bank corporate governance, a process that commenced more than two decades ago.

In this paper, I will first provide, in Part II, a brief outline of the eminent change in regulatory structure, so as to set the background for the present discussion. Part III will be devoted to a concise discussion of the historical evolution of the fit and proper test, demonstrating how it operated up until the 2007-2009 financial crisis. In Part IV, I will focus on the recent change in legal position and regulatory approach concerning the fit and proper test. In Part V, I will assess the potential significance of the reform both from a regulatory and a corporate governance perspective. Part VI will summarise the discussion and conclude.


II. The forthcoming change in UK regulatory structure

Before focusing on the 'fit and proper' test, it is useful to provide a concise overview of the imminent change in the structure of financial regulation in the UK. Due to the inherent information asymmetries and systemic risk in the banking industry there is a need for special regulation of banks and other financial firms and for continuous supervision of their activities by a public authority.