If the UK Financial Services Authority (FSA) had been a dog, it would have been about 86 years old when it was put down on April Fool’s Day this year. Uncharitably, some say that the FSA, the lead regulator for UK banks and insurers, was indeed a mutt that should have been dispatched long ago.
The short life of the FSA was book-ended by financial disasters.
After the failure of the venerable Barings Bank in 1995, regulation (or more correctly, self-regulation) of the banking industry in the UK was ripped away from the Bank of England (BOE) and the new FSA was given regulatory responsibilities by the Financial Services and Markets Act of 2000.
The FSA was brought undone, less than ten years later, by a number of financial debacles, not least the Northern Rock, PPI, and LIBOR scandals. As a result, the FSA was unceremoniously broken up by the UK government in the Financial Services Act of 2012.
The responsibilities given to the FSA by the UK Parliament, in 2000, were extensive and probably too broad. The FSA was not only responsible for regulating all banking and insurance corporations in the UK, but also for companies that operated investment and pension schemes. In its capacity as the UK Listing Authority (UKLA) , it was also responsible for ensuring that securities, such as equities, were issued by authorised firms. In 2012, the FSA employed about 4,000 staff in its many divisions to perform all of the functions allocated to it.
The main role of the FSA was as a “prudential” regulator, primarily concerned with maintaining financial stability and market confidence in the UK financial system. It also had secondary responsibilities for consumer protection (with regards to financial products) and the reduction of financial crime. The FSA exercised these statutory objectives by setting so-called “prudential standards”, which involved ensuring that banks and insurers were adequately capitalised for the risks that they were taking and were properly reporting their risks to their shareholders. Clearly, the FSA failed in its basic prudential regulation as some of the UK’s largest banks went to the wall during the GFC.
The FSA’s remit was enormous. But it should be remembered that regulators do not choose what they do, but are chartered by governments to do what governments want to do. If the job of overseeing the many thousands of UK financial companies, large and small, was too big for the FSA, it was the fault of the UK government and parliament, not the regulators themselves.
Interestingly, the FSA was not funded by the UK government, but by the firms that it regulated, through imposition of levies. Such a funding model is not without problems, as it would encourage any regulator to expand its remit rather than focus on the areas of greatest financial risk.
So what went wrong?
In the aftermath of so many scandals, it is extremely difficult to remember back to the halcyon days of banking before the GFC. Back in 2006, the landscape of banking was very different.
For a start, it was assumed that banks would compete fiercely with one another but would deal with their customers and shareholders honestly, or at least not do harm to them. Why on earth would anyone want to harm their own customers, since that is the very source of their long-term profitability?
Such an idea had to be unthinkable, but that is exactly what happened in many banks around the world. Take Goldman Sachs, which sold securities to “valued customers”, while at the same time betting against those very securities. If only Goldman had been the exception — but it was not. Almost every major bank in the world has been accused in the past few years of similar wrongdoing, if not on the same gob-smacking scale.
As private companies, banks were impervious to criticism before the GFC. As Lord Turner, last chairman of the FSA, told legislators, the hands of the regulators were tied:
“The global philosophy of regulation which was based upon too extreme a form of confidence in markets and confidence in the ideas that markets were self-correcting. This, in turn, had led to a belief that firms themselves could be left to make fundamentally sensible decisions.”
In other words, the market — not regulators — would sort out any problems.
In fact, banks behaved abominably, selling dodgy financial products to customers who often did not need the products and more often didn’t understand them. Unlike other goods, such as a motorcar, if a financial product blew up it was the fault of the customer rather than the seller, in the eyes of the bankers. The markets did not regulate misbehaviour because all the banks were all doing it.
Looking back, it was an Alice in Wonderland world where banking was just getting “curiouser and curiouser”.
After all the crises and the injection of billions of dollars of taxpayers’ money, politicians came to the blindingly obvious conclusion that bankers could just not be trusted to do the right thing. Some new regulations were needed to ensure that bankers behaved themselves.
In an example of kicking a dying man when he is down, the UK Parliamentary Commission on Banking Standards has just issued a report into the failure of Halifax Bank of Scotland (HBOS), entitled “An accident waiting to happen”.
This report not only roasts the Board and management of HBOS, but also crucifies the already dead FSA. “The picture that emerges is that the FSA’s regulation of HBOS was thoroughly inadequate [and] from 2004 until the latter part of 2007 the FSA was not so much the dog that did not bark as a dog barking up the wrong tree”.
The committees’ overall comment on the management of HBOS was that the bank was a ‘Manual for Bad Banking’ and that the bank’s culture “was brash, underpinned by a belief that the growing market share was due to a special set of skills which HBOS possessed and which its competitors lacked. The effects of the culture were all the more corrosive when coupled with a lack of corporate self-knowledge at the top of the organisation, enabling the bank’s leaders to persist in the belief, in some cases to this day, that HBOS was a conservative institution when in fact it was the very opposite”.
However, the FSA was not wholly to blame, as the committee admitted that “the experience of the regulation of HBOS demonstrates the fundamental weakness in the regulatory approach prior to the financial crisis and as that crisis unfolded”.
It is not only politicians and regulators that have to come to this conclusion. Last week, an independent review of Barclays’ business practices, headed by noted lawyer Anthony Salz, was published. The review, initiated by Barclays, discovered a plethora of bad practices in the recently repentant bank, from misselling of financial products to retail and business customers, rigging LIBOR, misreporting of assets, tax avoidance and more.
Mr Salz concluded: “Pay contributed significantly to a sense among a few that they were somehow unaffected by the ordinary rules. A few investment bankers seemed to lose a sense of proportion and humility.”
So how should such blatant misconduct and incompetence be regulated in future?
Since it was obvious that the FSA was too big and unwieldy already, the solution taken by the UK government was to split regulation across two major organisations.
In the new structure, prudential regulation was hived off to the Prudential Regulatory Authority (PRA) and, in an illustration that governments never learn the lessons of history, this body was handed back to the Bank of England, now rehabilitated after the Barings fiasco.
The second major regulator is new. It is the Financial Conduct Authority (FCA), whose remit is to “promote innovation and healthy competition between financial services firms. We help them keep to the rules and maintain high conduct standards”. This new regulator will be headed by none other than Martin Wheatlev who headed the LIBOR inquiry, so he is well aware of how big the task is going to be.
Of course, in regulation, one can never have enough acronyms and to oversee these two new regulators there is yet another regulator, the FPC (or Financial Policy Committee) which is to be part of the Bank of England. In other words: BOE 2, FSA 0.
Just to complete the carve up of the FSA, the small part of the old regulator that dealt with financial education has been split off as the separate Money Advice Service (MAS) whose remit is to “help people make the most of their money, we give free, unbiased money advice to everyone across the UK – online, over the phone and face to face”. It should be noted that in the USA, a similar independent body, the Consumer Financial Protection Bureau (CFPB), was set up under the elephantine Dodd Frank Act.
In this new regulatory world, UK and US banks need to be better corporate citizens and take the advice of Alice in Wonderland: “I can’t go back to yesterday because I was a different person then”. But until banks become “different persons: they will need robust regulation of their conduct, and hopefully they will get it.
There are lessons for Australia’s banking regulators, too. In the HBOS report, the parliamentary committee makes several comments on the disastrous lending policies of the bank, singling out Australia, where some 28% of business loans were eventually impaired.
It should be remembered that the Australian Prudential Regulation Authority (APRA) was the regulator for Bankwest (the local subsidiary), while "HBOS followed an ambitious growth strategy in Ireland and Australia, involving over-optimistic targets and assumptions for market share growth from local competitors”.
Surely such a risky strategy should have raised eyebrows at APRA headquarters? Not least when Bankwest was later acquired by Commonwealth Bank, albeit at a knockdown price and, as it later turned out, massive losses.
The issue of the now Australian-owned Bankwest and its treatment of local borrowers was vociferously raised during last year’s Senate Inquiry into the Australian banking system. Following the many allegations raised, not only on Bankwest, the final recommendation of the Senate Committee was that, “an independent and well-resourced root and branch inquiry into the Australian financial system be established”.
Where is that inquiry?