Financial Services Bill needs significant amendments if it is to help prevent a future crisis

19 December 2011

The Government must significantly amend the draft Financial Services Bill and clarify the objectives of the three new bodies that the Bill creates according to a report published today by a Joint Committee of MPs and Peers. The Committee believes the significant new powers and responsibilities being given to the Bank of England mean it must be modernised and made more accountable to Parliament.  And, to remove the confusion as to who was in charge which aggravated the last crisis, the Committee says that once the Bank identifies a crisis posing a threat to public funds the Chancellor must assume overall power and responsibility for handling it.

The Committee states that the legislation must clarify the objectives, powers and accountability of the three organisations it creates: - the Financial Policy Committee (FPC), the Prudential Regulation Authority (PRA), and the Financial Conduct Authority (FCA) to give them a clear focus and end the ‘fuzzy allocation of responsibilities’ identified by the Committee as a failure of the previous tripartite regulatory system.

The report points out that while the Bill focuses on regulatory structure, it is the culture, focus and philosophy of a regulator that has the greater impact on how it performs, and more needs to be done to foster a new regulatory culture.   A failure to look ahead for emerging risks was identified as a major failing before the banking crisis and the Committee argues that ‘judgement-led’ supervision, rather than focusing on a strict application of fixed rules, is vital for future regulation. Despite the Government’s claims that the Draft Bill will foster this, the Committee note that the concept is not mentioned once in the Bill and call on the Treasury to ensure this is enshrined in the legislation as a priority.

Key recommendations by the Committee include:

  • The Chancellor should be given an automatic power to direct the Bank of England when a material risk to public funds becomes clear.  The Chancellor must from that point on take responsibility for handling the crisis.
  • The Bill gives substantial new powers to the Bank of England. These should be matched by changes to ensure the Bank is suitably accountable to Parliament and the public. The Bank of England’s Governance structure should be changed with a new powerful Supervisory Board replacing the Court of Directors.
  • The Treasury and Parliament should exercise more oversight of the new FPC’s remit and its macro-prudential tools which can directly affect households and businesses.
  • The regulatory role of the new PRA should be widened to cover firms such as the UK operations of MF Global, the recently failed US futures broker, which would be outside the perimeter as currently envisaged.
  • The establishment of a high level Committee reporting to the Chancellor comprised of representatives of the PRA, FCA, Bank of England and Treasury to agree British objectives and maximise the UK’s influence in EU and international rule making.
  • The UK must be free to set higher capital requirements for banks than that required by the EU given the importance of banking to the UK economy.
  • Government legislation based on the ICB’s recommendation for ring-fencing retail banking should be included in the next legislative programme, subject to thorough pre-legislative scrutiny and implemented as soon as possible. But if the ICB’s proposed higher capital requirement is adopted there is a good case for allowing banks ample time to build up capital to avoid intensifying the credit shortage.
  • The objectives of the new conduct regulator, the FCA, should be rewritten to focus on promoting fair, efficient and transparent financial services markets that work well for users. The FCA should be given significant new competition powers including the power to make market investigation references to the Competition Commission and the power to hear super-complaints. The FCA should also be given responsibility for regulating the consumer credit industry.
  • To complement the consumer responsibility principle enshrined in the draft Bill a statutory duty should be placed on firms to treat their customers honestly, fairly and professionally. The FCA should ensure that companies address conflicts of interest and provide intelligible information to customers.
  • Banks have been involved in practices that were unethical and designed to maximise remuneration regardless of risk to the bank or the economy. The Government and the regulators should consider increasing the share of Executive remuneration that is deferred and conditional on medium term outcomes, or introducing a concept of ‘strict liability’ of executives and Board members for the adverse consequences of poor decisions, in order to ensure that  bank executives and Boards strike a different balance between risk and return.

Commenting on the report, Peter Lilley MP, Chairman of the Joint Committee on the Draft Financial Services Bill, said:

"The previous system of financial regulation failed to prevent the 2008 banking crisis or handle it properly. Under the Tripartite system no single body had the stability of the financial system as its primary responsibility and once the crisis erupted and differences about how to handle it emerged no-one person was clearly in charge.

It is vital that if the tax-payer might be liable for costs to save a financial institution that the Chancellor is given early warning of any such risk and then automatically assumes responsibility for handling that situation. It is the Chancellor who is responsible to Parliament and the public, and decisions of that nature must rest with him.

The Bill focuses on changing the regulatory structure – rightly putting prudential regulation back firmly within the Bank of England.  However, evidence from around the world convinced us that how well regulators did depended even more on their culture than on their structure.  So we propose clear objectives, powers and responsibilities and systems of accountability to foster the right culture and focus.

Above all regulators must move beyond just applying rules once problems have occurred – we need forward looking supervision to anticipate and prevent another crisis. The government accepts this but there is no mention of it in the Bill.   Judgement-led supervision needs statutory backing."

Further information

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