How effective has the FSA been at regulating banks?
This report looks at the effectiveness of the Financial Services Authority (FSA) in regulating the banking sector in the UK. The objective is to understand the role of the FSA, to evaluate its achievements so far regarding the Financial Institutions especially banks, and draw a conclusion as to whether it has met the targets set. The FSA website as well as the Bank of England (BoE) and the HM Treasury websites have been the main source of information. However journals have also been used through Metalib and Athens and newspaper articles.
1. Introduction
The Financial Services Authority, the Bank of England and the Treasury are three different bodies that deal with Financial Institutions and help to regulate them. Each of them has specific roles and this will be discussed in our report. The FSA also referred to as the city watchdog, however, is the single statutory regulator responsible for the authorisation and regulation of individuals and companies carrying out regulated activities.
2. What is the FSA, HM Treasury and Bank of England?
The FSA is an independent non-governmental body, given statutory powers by the Financial Services and Markets Act 2000. The BoE and the HM Treasury, in full Her Majesty’s Treasury, are governmental bodies.
The FSA is a limited company by guarantee, which means that it is, a non profit organisation whereby if they go bankrupt, the members guarantee to pay a sum of money to the company. The HM treasury appoints the members of the FSA board. This board sets out the overall policy whereas the day to day decisions and management of the staff are the responsibility of the Executive. When the FSA acts as the competent authority for listing shares on the stock exchange, it is referred to as the UK Listing Authority (UKLA) and maintains the official list.
The FSA was incorporated on 7 June 1985 under the name of The Securities and Investments Board Ltd (SIB) at the instigation of the UK Chancellor of the Exchequer, who was the sole member of the company and who delegated certain statutory regulatory powers to it under the then Financial Services Act 1986. The SIB revoked the recognition of The Financial Intermediaries, Managers and Brokers Regulatory Association (FIMBRA) as a Self-Regulatory Organisation (SRO) in June 1994 subject to a transitional recover period to provide for continuity of regulation whilst members moved to the Personal Investment Authority (PIA), which in turn was subsumed. The SIB changed its name to the FSA on 28 October 1997 and now exercises statutory powers given to it by the Financial Services and Markets Act 2000, which replaced the earlier legislation and came into force on 1st December 2001.
The Bank of England is the central bank of the United Kingdom and was founded in 1694, nationalised on 1 March 1946, and gained independence in 1997. Standing at the centre of the UK’s financial system, the Bank is committed to promoting and maintaining monetary and financial stability as its contribution to a healthy economy compared to the HM Treasury which is the United Kingdom government department responsible for developing and executing the British government’s public finance policy and economic policy.
3. Objectives of the FSA
The FSA was introduced due to a high demand by the consumers for a ‘one stop shop’ for the financial institutions and because UK has become one of the biggest providers of Financial Services.
In addition to regulating banks, insurance companies and financial advisers, the FSA has regulated mortgage business from 31 October 2004 and general insurance (excluding travel insurance) intermediaries from 14 January 2005.
The FSA has set out its aims in three broad headings which are (1) promoting efficient, orderly and fair markets; (2) helping retail consumers achieve a fair deal and; (3) improving business capability and efficiency. However, the four statutory objectives that have been imposed on the FSA by the Financial Services and Markets Act 2000 are: (1) market confidence; (2) public awareness; (3) consumer protection and; (4) the reduction of financial crime.
Furthermore, the FSA have regard to additional matters that they refer to as “principles of good regulation” which are: efficiency and economy, role of the management, proportionately, innovation, international character and competition
Overall responsibility for regulation of financial markets lies with HM Treasury and is then divided up between the Bank of England and the FSA.
Now, the Bank of England’s responsibility is the operation of monetary policy and ensuring the stability of the financial system. The change has been a move away from largely self-regulation to a combination of self-regulation and government interventionist regulation
After a series of scandals in the 1990s culminating in the collapse of Barings Bank, there was a desire to bring to an end the self-regulation of the financial services industry and to consolidate regulation responsibilities which had been split amongst multiple regulators.
4. Why the FSA was introduced?
Nowadays, financial markets tend to be more highly regulated than other markets. In May 1997, the British Chancellor of the Exchequer made the decision to move the responsibility of supervision of financial institutions into the hands of a new regulatory authority, the Financial Services Authority (FSA). This new authority replaced the Securities and Investments Board and took over responsibility for the supervision of banks, listed money market institutions and clearing houses from the Bank of England.
Before 1997 the UK relied primarily on private regulation by the stock exchange and, to an increasing extent, by the institutes of chartered accountants. The regulation of the financial system in the UK however is not as explicit as the system in the US where the Securities and Exchange Commission holds some of the most extensive regulations, which are viewed by some as being excessive.
So the UK’s new system is a compromise between the best of self regulation and statutory regulation to ensure the financial markets work in an efficient and orderly manner. The FSA reinforces the orderly operation of the UK markets. (LSE, 2008).
The frequently stated case for government regulation is based on the fact that failures in the market do occur and the interests of the public therefore must be protected. Bank failures around the world in the past 24 months have been common, large and expensive. This will be discussed further in the report.
The primary source of market failure comes from the monitoring and risk sharing. The BoE widely documented that risk sharing contracts make banks very susceptible to ‘runs’. The solvency of one bank may be affected by the failure of another bank because of loss of confidence and large-scale withdrawals usually as a result of a mismatch between the date to maturity of assets and liabilities. These bank runs can have a drastic effect on the public as banks are where the vast majority of people carry out their financial transactions such as savings and mortgages. The public tends to have an inherent trust in the banks and therefore depositors have a reduced capacity for evaluating and monitoring their banks.
Banks will not impose strict self-regulations unnecessarily. The danger of this situation is that banks might not provide services efficiently and therefore drag down the quality level of services in the industry, thus adding the need for the introduction of a regulating body such as the FSA. The need for public protection against these bank runs gives rise to the need for intervention to provide this protection.
Those who are against government intervention argue that it should be possible for banks to attain all levels of financing at any time in an efficient market, and that the existence of emergency financing will only ensure that banks will be negligent about their risk levels since they can rely on the central bank to aid any crises. In fact, banks hold forms of illiquid debt financing, so if a ‘run’ were to occur, it would not be possible to liquidate this debt. It has also been suggested that the real effects of a banking collapse are felt in the macro-economy. The banking collapse of the 1930s had severe effects on the ‘depth and duration of the Great Depression which followed’ and this is happening again since the collapse of Northern Rock.
5. What are Banks and the new Banking Code 2008
Banks form part of the Financial Institutions that are regulated by the FSA. Currently, banks regulate themselves through the Banking Code Standards Board (BCSB). Banks provide three primary services, the ‘efficient payments system and the management of asset portfolios’ and also ‘risk sharing’ and ‘the monitoring and screening of borrowers’.
In a consultation document, the FSA says the present set-up may be inadequate because the BCSB does not have the power to fine. The current banking code is supposed to ensure banks provide a fair deal to personal and small business customers according to the FSA. “Retail banking is going through a period of rapid change and regulation needs to keep pace with this change,” said Jon Pain, the FSA’s managing director of retail markets. The FSA also believes that in order to ensure that the regulatory model is fit to meet these challenges, now and in the future, the FSA should regulate the wider aspects of everyday banking for all consumers. (FSA, 2009)
The banking code was originally devised in 1992 and since 1999 has been enforced by the BCSB. Its current version was revised in March 2008. It sets down guidelines for the way banks deal with account holders and covers the way they market and operate their current and savings accounts. It also covers the way accounts can be opened and closed, and the information that should be given to customers about changes to their accounts. This includes the way changes to interest rates are communicated, as well as basic information about terms and conditions. The code also governs the way banks handle complaints or deal with customers who have financial problems.
In 2008, Alistair Darling introduced a banking special provisions Act which contradicts with what the FSA thought the current banking code was meant to ensure. It is an Act to make provision to enable the Treasury in certain circumstances to make an order relating to the transfer of securities issued by, or of property, rights or liabilities belonging to, an authorised deposit-taker, to make further provision in relation to building societies, and for connected purposes.
The Banking Act also referred to as the Special Provisions Act 2008 is an Act of the Parliament of the United Kingdom that entered into force on the 21 February 2008 in order to enable the UK government to nationalise high-street banks under emergency circumstances by secondary legislation. The Act was introduced in order to nationalise the failing bank Northern Rock after the bank had to be supported by BoE credit and a private-sector solution was deemed not to provide sufficient value for the taxpayer by the UK government. After the nationalisation of Northern Rock, the Act allowed for the nationalisation of the mortgage and personal loan book of Bradford & Bingley on 29 September 2008.
On 8 October 2008 the Treasury announced that an order under the Act was being used to transfer all retail deposits with Heritable Bank, a UK-based banking subsidiary of the failing Icelandic bank Landsbanki, and Kaupthing Edge to ING Direct. However section 2(8) of the Act provides that the Treasury may only make Transfer Orders under the Act for a maximum of a year after its passage. The Act therefore expired on 21 February 2009, when it was outdated by the Banking Act 2009.
In its consultation document the BoE said it has noted an increase in the number of complaints being made about bank accounts. “While these involve only a small percentage of total users, minor regulatory and market failures can add up to significant cumulative numbers,” it said.
It added that customers might suffer because the FSA was unable to enforce one of its main principles that “a firm must pay due regard to the interests of its customers and treat them fairly” and this gives an indication of the effectiveness of the FSA at regulating banks.
The FSA also said the scope of the current code was broadly correct and said the Banking Code Standards Board (BCSB) enforced it effectively. But the FSA suggested it wanted the code to be more of anticipation to bad behaviour and therefore prohibit individuals from selling financial products. In 2008-09 the number of prohibited persons almost doubled, compared with the previous year, to 55. Since 2005-06 the number of banned individuals has gone up almost eightfold. This however doesn’t mean that the FSA is being efficient.
6. Evaluation of the FSA
The City watchdog banned the Dorset mortgage brokers Peter and James Dean for failing to prevent their firm from being used to perpetuate financial crime and for other serious regulatory failures. Peter Dean was also fined �17,500.
The FSA also withdrew authorisation from Eastbourne Financial Services, a business that claimed to offer a unique service to mortgage brokers requiring niche facilities. Nine people were arrested in police raids on suspicion of a �40 million fraud against Bradford & Bingley. Eight were linked to Eastbourne Financial Services.
(http://www.economist.com/world/britain/displaystory.cfm?story_id=13343131)
A spokesman for the FSA said that they have made a step change in the way they are dealing with mortgage fraud, including increasing fines to act as a deterrent.
(http://www.timesonline.co.uk/tol/money/savings/article6011831.ece)
Two areas that the FSA is not proposing to regulate are the way in which banks provide unsecured loans and credit cards, for which the Office of Fair Trading (OFT) is already responsible.
Its plans would apply not only to banks but also to building societies and credit unions.
Even if the FSA thinks that they have made a big change in the way they are dealing with frauds, articles and a journal about how effective the FSA has been tend to contradict how good the FSA is.
People have been criticising that FSA shouldn’t have opened in the first place as the 10 years of FSA has only been of huge policy mistakes according to survey made on the Economist newspaper. The old system of the treasury and the Bank of England would have been a better option.
According to the Inland Revenue, the banking, finance and insurance industry made taxable profit of �42.269 billion in 2004-05. The total amount of fines imposed by the FSA in 2005 was �16.9 million – 0.04% of profits which is less than a tenth of half a penny in the pound.
The FSA had a major role to play in during the credit crunch with the collapse of Bradford and Bingley, RBS and HBOS.
The FSA has been blamed for failure to identify the banks poor lending activities in time which have led to the current economic crisis. The need to identify the amount of credit to be provided and how much it should be has led to banks lending to the incorrect people. Mortgages in the past have been provided to people who are not believed to be credit worthy and in the future they have been unable to keep up with their repayments. Hence the banks have been left with no money for the investments that they made.
For this reason, the largest and most unpopular story has been that of the Royal bank of Scotland. The RBS is the largest mortgage lender in the UK and they have suffered massive losses due to the poor practices in lending out money. The result has therefore meant that the government provide tax payers money to make sure that the bank is still running as they want to secure jobs and give confidence to the public about the money that has been invested.
7. G20 Summit London – 2nd April 2009
Financial Situation
There will be more systematic cooperation between countries, and the framework of internationally agreed high standards, that a global financial system requires. They agreed to strengthened regulation and supervision must promote propriety, integrity and transparency; guard against risk across the financial system; dampen rather than amplify the financial and economic cycle; reduce reliance on inappropriately risky sources of financing; and discourage excessive risk-taking. Regulators and supervisors must protect consumers and investors, support market discipline, avoid adverse impacts on other countries, reduce the scope for regulatory arbitrage, support competition and dynamism, and keep pace with innovation in the marketplace.
To this end a Financial Stability Board (FSB) has been established with a strengthened mandate, as a successor to the Financial Stability Forum (FSF), including all G20 countries, FSF members, Spain, and the European Commission. The FSB should collaborate with the International Monetary Fund (IMF) to provide early warning of macroeconomic and financial risks and the actions needed to address them. The FSB will be responsible to take action, once recovery is assured, to improve the quality, quantity, and international consistency of capital in the banking system. In future, regulation must prevent excessive leverage and require buffers of resources to be built up in good times. They will also extend regulatory oversight and registration to Credit Rating Agencies to ensure they meet the international code of good practice, particularly to prevent unacceptable conflicts of interest
International Financial Institutions
The G20 agreed to ensure that the international financial institutions have the facilities they need to address the current crisis and meet the needs of emerging markets and developing countries. The IMF should take steps to ensure that its surveillance and lending facilities address effectively the underlying causes of countries’ balance of payments financing needs, particularly the withdrawal of external capital flows to the banking and corporate sectors.
8. BBC interview with Lord Turner – What went wrong
According to an interview taken on 15th February 2009 by the BBC, Lord Turner (chairman of FSA) admitted that FSA have been focusing more on the reporting lines of processes, structures and procedures rather than focusing on the fundamental economics. He admits that the FSA has been focusing on individual institutions and the process is not totally focused on the totality of wider systematic risk that cost the whole system. This systematic failure has leaded to bank crisis. He states that the FSA has been risking the failures but is trying to solve it through risk mitigating programmes which covers every single institution for which they are worried. A risk mitigating programme has 50 action points for major institutions which includes insurance companies or banks.
A lot of what FSA does has nothing to do with prudential regulation of Banks. Lord Turner feels sorry for the intellectual failure to focus the systematic sustainable risks not only in the UK but around the whole world. The report which he published on March 18th has the review of all the different regulations. The regulation will set out major changes about the capital which banks have to hold with the trading book and the way they regulate their liquidity. It also tells about the remuneration on credit agencies and the FSA supervisory process which needs more people with higher qualities.
9. What could have been done differently?
The main question that is asked is what the FSA could have done differently. As a watchdog, they should have identified the poor lending that was going on and addressed this to the government. This would have allowed for a review in the practices and these activities could have been minimised.
There were critics who had predicted the economic slowdown due to the poor lending. Some critics are very learned in the financial sector and believe that the FSA should have paid attention to the advice that they were provided with.
Another major point that has not been considered is that the FSA are the regulatory body but there is no one to regulate the regulators. Fingers could be pointed at the FSA for their failures but the government has failed to realise that there should have been a body to supervise the FSA as a company at whole as they themselves are prawn to getting it wrong. For this reason, the FSA had been given the freedom to make decisions on regulation. These decisions were normally unchallenged and hence the crisis in the banking sector.
It would be advisable that the FSA adopt the system of regulation as that practised in France. The regulator in France has subdivided themselves into small subdivisions in order to allocate each other responsibility as a regulator. This will ensure that every sector of the financial services is covered and is well represented.
The FSA would set out the rules for financial institutions on lending. The responsibility should be passed on to departments in the banks, ensuring that every financial institution has a department that would calculate the risk that the company is exposed to for every investment that they make. This will allow the companies to know what they will be suffering individually and if the investments would be worthwhile undertaking.
The FSA have also recommended that they would regulate the kind of investments that the banks make. They want the banks to make more cash or liquid investments and this kind of practise would have prevented the fateful takeover of the Dutch bank ABN Amro. The bulk of what the RBS paid for was goodwill. This is not an asset that the bank could sell on in future. If the FSA could have regulated this in the past, these kind of activities have led to scenarios where shareholders losing confidence in the banking industry.
10. Lord Turner – 18th March 2009
The FSA plans to look beyond single institutions to the systemic risks they may be heaping up in aggregate. It will check that pay does not give bankers an incentive to take on more risk than the bank can safely manage and will rationalise the wildly different ways in which banks account for complex assets.
The FSA wants to make banks keep more capital to cushion possible losses on the assets they hold to trade, and proposes bigger charges on those that are likely to be harder to sell in a crisis. It will put less trust in the home supervisors of the many foreign banks with branches in Britain: the bankruptcies of Lehman Brothers and two Icelandic banks had financial repercussions in the host country. European Union banks branch freely in other member states, a principle that may need revision.
Lord Turner, who took over last September, and about 200 new specialists hired to sharpen supervision, the old crew is still there. “Light touch” regulation, which gave bank bosses plenty of room provided they seemed to know what they were doing, is to be replaced with a much heavier hand, but it is attached to the same people. So will they be able to rise up to the challenge now?
Lord Turner dismisses past errors as the result of a mistaken worldwide philosophy which held that markets and those competing in them could safely be left to self-correct. Banks will no longer be allowed to rely on deposit insurance and being “too big to fail” as a basis for taking big bets, he says. But he stops short, as do most policymakers, of calling for a split between banks that operate as a casino, playing the markets actively for profit, and those that see their role mainly as a utility, converting deposits into loans, processing transactions and the like.
Whether it was the policies or the personalities that were wrong, the system didn’t work. But Mr Brown, now prime minister, is not a man to admit that he has made a mistake. Nor does Lord Turner believe that tinkering with the structure will improve supervision. One of the FSA’s proposals, however, does include strengthening the central bank’s systemic-scrutiny role; giving it power to adjust banks’ capital charges to mitigate booms and busts.
Designing sturdier financial regulation is high among most countries’ priorities these days. But Britain faces a particular dilemma: it may have to choose between continuing to host the world’s biggest international financial centre, with the jobs and revenues this has brought, and cracking down on excessive risk-taking. Investment banks are already threatening to take their trades offshore if the FSA goes ahead with proposed new rules on liquidity.
Lord Turner hopes such rules will be applied globally. But that will happen slowly, if at all. The FSA may enjoy its reprieve only until the next election.
11. Conclusion
Hector Sants, the FSA Chief Executive, said in a speech at the start of March “There is a view that people are not frightened of the FSA,” And they have very good reason not to be frightened.
The FSA behaves more like the DVLA, who licence you to drive a car, than they are like the police, who enforce that you drive it properly. The DVLA is not responsible for enforcing what you do with the car – speeding, drunk driving, stealing, hit and run. That is what the police are there for. If a little old lady gets knocked over on the street, it is the police’s responsibility to find the driver and take him to court not the DVLA. On the other hand, if a little old lady gets ripped off by a bank, then she is on her own – as can be seen by the multiple private individual actions taken to reclaim bank charges.
No-one in their right mind assumes that just because you’ve got a driving licence you are a good driver. However, the assumption peddled by financial institutions, with the tacit complicity of the FSA, is that if you are regulated by the FSA you aren’t a crook or an imbecile.
From the FSA’s own statements, “enforcement is a relatively small part of our (the FSA’s) work.” (FSA Enforcement Annual Performance Account 2005/2006). They state in their ‘statutory objectives’ that they aim to secure “the appropriate degree of protection for consumers”, where the “restrictions we impose on the industry must be proportionate to the benefits that are expected to result from those restrictions”. Appropriate degree of protection by imposing proportionate restrictions on the industry? Nothing there about the rule of law, and primacy of Justice.
Perpetrators of financial scandals are given the lightest possible tap on the wrist by the authorities. Fines for institutions that mis-sold endowments, inflated stock prices, overpriced insurance, overcharged etc. are an ignorable small percentage of their dubiously gotten gains.
The banks were fined a small percentage of their profits, which would have received a far greater boost by the culture of dubious practice. Dubious practice in the areas they were caught out, and also the many more areas they weren’t. What would you think if a convicted burglar was fined 10% of what he pinched, and was allowed to go home with the rest?
His Honour – “Return the radio immediately. You can keep the flat screen TV and camcorder. I hope you have learned your lesson.” Burglar – “I certainly have your honour. Clear as day.”
Many institutions will not even regard these fines as a penalty, but more as a cost of doing business. If you choose to occupy a fancy office, then you pay rent. If you choose to occupy and cross the boundary of mischievous business practice, you pay rent for that too in the form of a fine. Rent isn’t levied to persuade you to leave your premises. FSA fines aren’t levied to persuade you to stop screwing customers.
And with a revolving careers door between regulator and regulated, the chances of the FSA execs muddying their future employment prospects by being tough on the financial services industry are pretty slim. Hope the new policies will help solve the problem.
(2210 words)
Reference List
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