Select Committee on Treasury Seventeenth Report


The need for change and our proposals

In January, we reported on the crisis at Northern Rock and the lessons to be learned from that episode for the Treasury, the Financial Services Authority (the FSA) and the Bank of England—together known as the Tripartite authorities. In this Report, we consider the further changes that are needed, both legislative and practical. We conclude that the overall case for legislative action in the field of banking regulation is compelling, but we are concerned about whether the Government's preparations for the new legislation are sufficiently advanced for the new legislation to be in place by late February 2009. We recommend in particular that the final legislation provide for—

  • Greater clarity about the nature and objectives of 'heightened supervision'—the 'amber' stage preceding the proposed Special Resolution Regime;
  • An explicit statutory power for the Bank of England to recommend to the FSA that a firm be made subject to the new Special Resolution Regime; and
  • A clear institutional separation between the executive functions of the Bank of England relating to financial stability, which should be the responsibility of the proposed Financial Stability Committee, and the non-executive role of the Court, which should have a clearer mandate for internal accountability.

New legislation must not be seen as a panacea for the failings within the Tripartite arrangements. Practical steps must be taken in parallel with the creation of the new legislative framework. In particular—

  • The FSA must continue to strengthen its capacity to regulate to reduce the need for the use of the Special Resolution Regime;
  • The Tripartite authorities must develop an effective external communications strategy to help to secure public and market confidence in the exercise of their new powers; and
  • Depositor protection arrangements must be developed which will function smoothly and effectively in the event of a bank failure, including in the event of the failure of a European Economic Area (EEA) bank with a branch or branches in the United Kingdom.

'Heightened supervision' and the Special Resolution Regime

We conclude that 'heightened supervision' must be considered as a distinct and separate state of supervision, segmented from both normal supervision and from the Special Resolution Regime. We recommend that the FSA be placed under a statutory duty to prepare, and consult on, a Code of Practice for Heightened Supervision. We agree with the current proposal 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 recommend that the Bank of England be given a power enshrined in primary legislation to recommend that a financial institution be brought within the Special Resolution Regime. We also recommend that the new legislation require that, when a Tripartite authority exercises a power under the Special Resolution Regime, that authority publish, or record for subsequent publication as appropriate, an assessment of the reasoning behind its decision.

Protecting depositors

We identify priorities for reform of the Financial Services Compensation Scheme (FSCS). In particular —

  • the Tripartite authorities must stand firm in their determination to introduce tough deadlines for processing compensation payments;
  • the authorities must ensure that a bank's inability to calculate individual compensation payouts immediately does not jeopardise the proposed seven-day payout target; and
  • the FSA must seek a resolution to the unreasonable difficulties faced by consumers having to know whether their bank has an individual, or shared, banking licence.

We call for the Government to set out a proposed timetable for the implementation of pre-funding for depositor protection. We recommend that the FSA be given powers to postpone or suspend levies for the banking sector as a whole at a time of financial crisis and to vary contributions according to its assessment of the risk profile of individual institutions.

We recommend that the FSCS take responsibility in appropriate cases for deposit protection for United Kingdom customers of EEA banks with a branch or branches in the United Kingdom on the same basis as for United Kingdom banks. The FSCS would then claim reimbursement itself from the home-state deposit protection scheme of a failed bank, acting as it does when it takes the place of insured depositors in the winding-up of a United Kingdom bank.

Strengthening the Bank of England

We set out proposals for a clear institutional separation between the executive functions of the Bank of England relating to financial stability and the internal accountability functions of the Court. We recommend that the proposed Financial Stability Committee be established in statute with a status comparable to that of the Monetary Policy Committee—with overall responsibility for the discharge of the Bank of England's financial stability functions and with a composition on similar lines to that of the Monetary Policy Committee. We recommend that the Non-executive Directors Committee of the Court be placed under a statutory duty to perform an internal accountability function in relation to the financial stability work of the Bank. We propose two financial stability objectives for the Bank of England, one relating to the priority accorded to financial stability work within the Bank and the prerequisites for the Bank to carry out that work effectively, and the second relating to the Bank's role in responding to crises in a way which minimises their spill-over effects and thus the damage caused to the United Kingdom financial system and its reputation and to the United Kingdom economy more generally.

Strengthening the Tripartite arrangements

It is of vital importance that the Tripartite Standing Committee is not perceived as a sleepy backwater in normal situations which must begin its work almost from scratch in a time of crisis. That Committee must assume a central and continuing role in the financial stability work of the authorities at all times. To strengthen the working of that Committee, we recommend—

  • a small central secretariat to staff the Committee to ensure appropriate levels of continuity and expertise; and
  • mechanisms for external communications in a financial crisis that are established in advance; and
  • regular testing of the use of the new powers in different scenarios.

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Prepared 16 September 2008