UK's authorities push for rigorous reform

LONDON - On the same day Lehman Brothers filed for bankruptcy protection in the US, the UK Treasury Committee released its banking reform report. The document sets out proposals in the light of the recent consultation papers (CPs) on financial stability issued by the the UK Financial Services Authority (FSA), the Bank of England and the Treasury, which will be solidified in law once the Banking Reform Bill is passed.

The report calls for a reform of the Financial Services Compensation Scheme (FSCS), urging the UK's authorities to introduce tough deadlines for processing compensation payments. It also reiterates the Committee's support for an element of pre-funding of the FSCS, but recommends such a scheme should be flexible enough for contributions to be suspended at times of economic crisis. To strengthen the Bank of England's role in financial stability, the report recommends the proposed Financial Stability Committee be established with a status similar to that of the Monetary Policy Committee.

The most contentious recommendation in this report and in the previous tripartite CPs is the Special Resolution Regime (SRR) - a mechanism that will allow the tripartite authorities to intervene when a bank gets into severe difficulties, including the introduction of an insolvency regime for banks. The report reads: "The Committee agrees with current proposals that the FSA be granted the sole responsibility for the 'pulling of the trigger' to make an individual firm subject to the Special Resolution Regime, but it recommends the Bank of England be given a power enshrined in primary legislation to recommend to the FSA that a financial institution be brought within the Special Resolution Regime."

Investors and city commentators have been outspoken in their objections to the SRR, which they fear will hit confidence as, under the new legislation, shareholders in troubled institutions could effectively be stripped of their rights. In an article published in UK newspaper The Daily Telegraph on September 15, Peter Montagnon, director of investment affairs at the Association of British Insurers, warns this quick reaction to the Northern Rock crisis and other recent events "risks compounding the problem they set out to solve," and that, "sadly, the proposed arrangements are likely to leave investors less confident than they were before and less willing to commit resources to banks. The consequence will be that the cost of capital to British banks will rise."

Montagnon calls for a more measured approach and the use of the SRR only as a last resort. He says any decision to pull the trigger should only follow consultation with investors to see if they would accept an alternative solution, ostensibly by putting up more capital. Once the authorities do intervene, they should have "as one of their formal objectives, a clear obligation to maximise the enterprise value of the bank in the interest of all stakeholders".

Despite the controversy, the Banking Reform Bill is expected to be passed in the next parliamentary session and has the support of the opposition Conservative party, although it has stated it would go further and hand the regulation of the banks back to the Bank of England.

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