FSA chairman gets tough on liquidity issues

Chairman McCarthy defends tripartite system and promises action on liquidity regardless of Basel Committee delays

LONDON – Callum McCarthy, chairman of the UK Financial Services Authority, gave a determined speech to delegates at the annual British Bankers’ Association conference yesterday, confirming the benefits of the regulator’s role as the single supervisor of all financial institutions irrespective of their business type, alongside vigorously defending the use of principles-based regulation. McCarthy also stated that tougher liquidity rules for financial institutions were badly needed, sooner rather than later, and promised to plough ahead with plans to reform the rules even if the Basel Committee continued to delay in setting out an international response to the credit crisis.

“I know international banks would like to manage their liquidity globally, subject to one global, not several national, set of rules,” said McCarthy. “But, unless there is a step change in the speed with which the Basel Committee progresses international agreement, regulators will be forced to deal with this on a national level. That is what we plan to do in the UK. I am of course very keen that the Basel Committee should actively consider whether it can develop a resilient approach to the cross-border management of liquidity for banking groups, which meets the most compelling requirements of regulators and industry alike. But we cannot delay.”

The collapse of Northern Rock in the UK, coupled with the intense media attention, has made it even more vital for the FSA to be seen to be acting on reforming the liquidity regime, which has been shown to be wholly inadequate to deal with the current market situation. In December the UK tripartite authorities – the FSA, Bank of England and Treasury – set out for consultation a series of measures designed to improve the UK's liquidity regime. Initial feedback suggests respondents broadly agreed with the policy objectives set out in the paper. There was strong agreement on the importance of the close relationship between the central bank’s role, actions and provisions, and firms’ internal liquidity risk management processes, as well as any measures developed by the FSA under a new regulatory regime. Respondents also agreed that quantitative requirements were a necessary component of any liquidity regime, particularly for the short term, and thought one single quantitative regime should replace the existing three.

The FSA will consult further on all aspects of the new regime later this year, including setting out proposals on sound practices for managing liquidity risk with a strong focus on stress-testing. These enhanced qualitative requirements are intended to reflect the work being carried out by the Basel Committee and form the centrepiece of the new liquidity policy – the Committee is due to submit a set of high-level principles within the next few weeks.

McCarthy also set out how the new resolution framework, due to be introduced in October, will work in practice. The critical elements of the proposal include the explicit legal recognition of the Bank of England’s core responsibility for financial stability and changes to the oversight of this responsibility by the Court; a range of measures designed to improve the supervision of financial institutions, to make failures less likely; the introduction of a resolution regime to deal with failing banks; changes to the compensation scheme, to make it easier and faster to pay off depositors in the event of failure; and measures to build on and improve the co-ordination of the Tripartite Authorities.

The FSA chairman also confirmed that the supervisor will be paying more attention to how a firm’s incentives structure is arranged: “I think it entirely appropriate for supervisors, as part of our general assessment of systems and controls, to be interested in compensation and incentive structures, and – just as we take other aspects of a bank’s control philosophy and practice into account – to adjust our assessment of prudential requirements, including capital, for a bank accordingly,” he said.