'FSA failed dreadfully' says Treasury Committee

A report on financial regulation published by the UK parliament's Treasury Select Committee criticises the UK Financial Services Authority over its handling of the credit crisis.

The report, entitled Banking crisis: Regulation and supervision, was released on July 31. "By any measure the FSA has failed dreadfully in its supervision of the banking sector," the Committee wrote, citing a lack of confidence to follow through with unpopular decisions when faced with resistance from the industry or from politicians.

The Committee also said the FSA was lax in its assessment of candidates for senior banking posts. "The FSA's assessment of whether senior bankers were fit and proper for their posts appears to have been little more than a tick-box formality," the report claims, adding the regulator should have been more diligent in checking for relevant qualifications or experience. The regulator should also be given more autonomy to support systemic stability without needing to justify its actions to the government or the industry, the Committee added.

The report identified four other areas in need of improvement: systemically significant banks, international regulation, macroprudential supervision and institutional reform.

The Committee pointed out that banks that are 'too big to fail' can exploit their implicit guarantee of public support: "In other words, banks can play a high-stakes casino table with the taxpayers' chips." It suggested a "tax on size" administered through the capital regime, with higher capital charges for more complex, interconnected banks – similar to the additional capital requirements for systemically important banks proposed by the US government in June. The report does not rule out the possibility of a ban on proprietary trading by deposit-taking banks at this early stage in the debate – a move originally suggested in January by the G-30 group of banks and regulators.

The international nature of these large banks also came under scrutiny. "Whilst banks may be global in life, they are national in death, because if such a bank were to fail, the regulator in the bank's home state would have the responsibility of resolving the firm," the report said. The Committee therefore recommends national banking units of global banks be obliged to establish as standalone subsidiaries of a parent group, supervised by the host state regulator. Resolving a failed bank would also be easier if banks were compelled to prepare "living wills" – advance plans for their own orderly winding up or restructuring, as recommended by the Bank of England in June – which would help to deal with problematic off-balance-sheet vehicles.

The Committee echoed concerns that regulatory action tended to amplify the credit cycle. "Financial markets have proven vulnerable to the collective temptation to lend too freely when times are good, only to rein in lending unduly when the economic cycle turns," the report said, calling for the introduction of a leverage ratio, regulatory reform in the area of loan-to-value ratios and countercyclical capital rules.

The Committee also argued that existing plans for reform were not enough – as well as the "largely cosmetic" replacement of the Tripartite Standing Committee by the Council of Financial Stability, it said reforms should clarify the responsibilities of the Council's members. "When the dust eventually settles on a new system," it concluded, "the question that we and others will ask is, ‘Who gets fired?'" 

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