Watchdog pays price for lack of vigilance

IT WAS once a powerful member of the tripartite regulation system alongside the Bank of England and the Treasury. But the Financial Services Authority is to be reduced to what has been described as nothing more than a consumer watchdog as part of sweeping reforms aimed at preventing a repeat of one of the most serious financial crises to hit the UK.

Proposals announced last week by Chancellor George Osborne revealed plans to dismantle the FSA – and reassign the majority of its powers to the jurisdiction of the Bank of England.

The writing has been on the wall for the FSA for some time. In search of a scapegoat at the advent of the financial crisis and the subsequent recession, fingers soon began to point at the regulator.

It came under fire for failing to spot the over-expansion and risky lending going on behind closed doors at some of the UK's biggest and most important banks. Essentially, the organisation failed to carry out its most important role – to identify that a bank is failing and pass that information on to the Bank of England. Now it is feeling the backlash.

Much of its existing remit will be devolved to two new Bank-controlled regulators: a new Consumer Protection and Markets Authority and a Prudential Regulation Authority, which will be charged with overseeing the dealings of financial institutions.

Macro-prudential regulation and oversight of micro-prudential regulation will be dealt with through yet another new Bank organisations – the Financial Policy Committee. An Economic Crime Agency will also be set up to deal with any unlawful goings-on in the financial world.

But Ben Thomson, chairman of Edinburgh-based investment bank Noble Group, is sympathetic towards the regulator.

"The problem is that what they did was reactive," Thomson said. "The FSA was really just a policeman and there was always the potential for failure. Given that the boards of the banks themselves found it difficult to find out what was going on, how on earth could the FSA do it? It was very much a rules based organisation. And if you look at it on that basis, no-one really broke the rules – except the odd person like Madoff."

The FSA's chairman, Lord Turner, once a darling of the Labour government, will be left in charge of a fairly powerless consumer rights body.

But Hector Sants, the current chief executive of the FSA, has been handed a new lease on life. Before the election, Sants said he would leave the regulator. But now, as the new deputy governor of the Bank of England, he will oversee the transition and, by 2012, when the new regime is set to take power, he will then head the new Bank prudential regulator.

"While I believe the Bank of England is the right organisation to regulate the markets – they are out there, they are doing their own research – my fear is that if they essentially move over the powers the FSA had to the Bank and move the people with it, it will essentially be the same people doing the same jobs," added Thomson.

The shake-up of the regulatory system is just one part of Osborne's plans.

By September 2011, the Independent Commission on Banking, headed by former Bank chief economist Sir John Vickers, will return with a report outlining how corporate risk can be cut in the banking industry, what should be done to "mitigate moral hazard" and how best to encourage competition in the banking sector.

But, perhaps most importantly, the inquiry will discuss the potential break-up of Britain's banks.

Certain members of the committee – including former Barclays chief executive Martin Taylor – are already well known for being less than keen on continuing to combine retail and investment banking in the same institution.

The decision will finally give a full overview of the landscape of British banking – but some have raised questions on the necessity for a 15-month wait.

Philip Augar, a former City equity broker and the Scottish Government's adviser into its inquiry into the future of the financial services industry, said he feared the lengthy inquiry would cut the UK adrift from a more global strategy.

"By the time the commission deliberates over its decision, the question is raised as to what other global nations will have done in that period," he said. "Some have been asking for an independent commission for a long time. Now it has been created, we should welcome it. But structural change really needs to be part of a wider global initiative."

Indeed, some have raised fears that the wait for a decision is essentially the same as slapping a hiatus on the development of the banking sector.

While the future of Britain's – and more specifically, Scotland's – larger banks is uncertain, there is not likely to be much serious business development. Share prices may remain stagnant and potential suitors of those sections of banks' business currently sporting a "for-sale" sign may slip back into the shadows until a more certain future is revealed.

Augar is keen to now take a step back and allow the commission to do its worst. But he has previously been a vocal supporter of need for "serious banking reform" – and a total separation of retail and investment banking operations.

He and his supporters believe a split would be "essential" to restore competition in the banking sector.

Angela Knight, chief executive of the British Bankers' Association (BBA), has made it quite clear that she believes a break up of the banks would "seriously damage" the UK economy.

Critics have raised fears that rules stopping British banks from running both investment and retail banking operations could send global institutions such as HSBC and Standard Chartered running overseas, while questions remain unanswered as to whether foreign banks would be allowed to operate both types of banking on British soil – with only their UK rivals shackled by the new regulations.

"It will not so much be the architecture of the participants in retail and investment banking which will determine the riskiness of their operations but the effective regulation of their activities," said Tony Anderson, banking partner at law firm Pinsent Masons. "The findings of the commission on reducing systemic risk will be more critical."