One notable consequence of the recent global financial crisis is the recognition that existing regulation of financial institutions has failed. Self regulation via banking codes failed to prevent the 2008/09 banking crisis, as did national regulation.
The growth in high risk trading of extremely complex financial products, including derivatives and options, and the increasing securitisation of assets, created what has widely been dubbed a shadow banking system, which increasingly operated outside of normal banking practices.
Like all large businesses, banks are subject to regulation by the OFT and the Competition Commission. As early as 2001 the Competition Commission concluded that a number of the largest banks operated a complex monopoly in the supply of services to small and medium sized enterprises (SMEs) which resulted in reduced competition to the detriment of the customers. For example, customers were reluctant to switch banks because they all offered very similar benefits.
The tri-partite system
Until the banking crisis, UK banking regulation could be described as light-touch - in other words, regulators do not engage in aggressive regulation, preferring to intervene only when necessary, and only in limited ways.
The main problem for the regulators was that the heavy-touch regulation might force global banks to seek out countries where regulations were less strict. In other words, they would move out of London, leading to huge job losses in the City. (Source: Reuters)
The role of the FSA
The main UK bank regulator is the Financial Services Authority (FSA). It has two main objectives:
- To promote efficient and fair financial services
- To help consumers of financial services achieve a fair deal
To achieve this the FSA sets standards for the activities of banks and other financial businesses, and can take action to ensure these standards are met.
Rules vs Principles
Some critics of the US regulatory system maintain that it is too 'rule-based' and should move towards the European model of 'principle-based' regulation.
With rule-based regulation the regulators interpret the rules as laid down in law, and there is little room left for judgement or interpretation.
Under a principles-based system the general principles are contained in legislation, and this gives regulators extra powers to to assess the behaviour of financial institutions.
The Banking Act 2009
In order to protect depositors and to maintain financial stabilit, the Banking Act of 2009 gave the those organisations responsible for banking regulation the collective powers to deal with the crisis in the banking system. One of these powers is the ability to put a failing bank under temporary public ownership.
The Turner Review
In March 2009 Lord Turner, Chairman of the FSA, published the findings of his review into the banking crisis and recommended the following:
More coordinated international banking regulation, especially the creation of a pan-European regulator
Banks to hold more assets
Regulation of liquidity
More information to be collected from those institutions that are part of the shadow banking system, like hedge funds.
More regulation of overseas banks by host countries - this recommendation is largely in response to the collapse of the Iceland banks, who were unregulated by the UK regulators, but UK citizens suffered large losses.
Control of bank employees remuneration
A review of bank's accounting practices