Financial Regulation: a preliminary consideration of the Government's proposals - Treasury Contents


Written evidence submitted by the British Bankers' Association

INTRODUCTION

  1.  The British Bankers' Association welcomes the opportunity to give evidence to the inquiry by the Treasury Committee into the Government's proposals for changing the framework for UK financial regulation. We represent 220 banks from 60 countries and have 40 associate firms within membership.

  2.  As the inquiry notice observes, the Financial Services Authority (FSA) will cease to exist in its current form and will be replaced by two new bodies—the Prudential Regulation Authority (PRA), a new subsidiary of the Bank of England focusing on the regulation of banks, deposit-takers and insurers; and the Consumer and Markets Authority (CPMA), which will be responsible for consumer protection and market conduct. A new Financial Policy Committee (FPC) will also be made responsible for macro-prudential policy and will sit alongside the Monetary Policy Committee (MPC) within the Bank of England. Given the critical nature of these changes it is right that the Treasury Committee has determined that it should take an interest in their development from the earliest possible stage.

  3.  We have little issue with the broad institutional changes envisaged by the Government in that they:

    — Create greater focus on the different regulatory disciplines of prudential supervision and conduct of business;

    — Place within a single body—the Bank of England—responsibility for macro-prudential supervision; and

    — Provide for better coordination between macro and micro-prudential regulation through the establishment of the FPC and the Bank of England's oversight of the PRA.

  4.  But we do believe that new institutional structures bring a new set of challenges to be addressed and it is not at all clear to us that the various issues raised by the proposed arrangements have been as fully thought out as they need to be. As matters stand, we see shortcomings in the democratic accountability of the proposed bodies, their proposed objectives, and the planned arrangements for due consultation process. We believe that the importance of the involvement of the Treasury may have been underplayed as a result of the falling away of the Tripartite arrangements and can also see imbalances in the arrangements for the PRA and CPMA. We are concerned in particular that insufficient emphasis may have been placed on the need to maintain a coherent markets division capable of representing the UK interest in European and international fora.

THE BANKING REFORM PROGRAMME

  5.  The Treasury paper (Cm 7874) opens by explaining that there is an emerging consensus on the fundamental cause of the crisis and we would not disagree with the key factors identified: global economic imbalances; mispriced and misunderstood risk; unsustainable funding and business models for banks; excessive build up of debt across the financial system; and the growth of an unregulated "shadow banking" system. We would add monetary and fiscal policies to the list since the financial sector cannot be said to be the main driver of economic cycles and we would be missing a vital part of the picture if we were to overlook this.

  6.  Some of these factors have been the subject of the programme of banking reform begun by the then Financial Stability Forum (now Board) and subsequently adopted by the G20.[14] The reform of the regulatory and supervisory architecture undertaken to date can be said to have focused on two overarching objectives: reducing the probability and systemic impact of an institution failing:

    — Measures to increase the resilience of the banking industry include banks holding more loss-absorbing types of capital, increased capital requirements against the trading book and putting in place better liquidity buffers. It also includes improvements in corporate governance, risk management, supervision, accounting, and product simplification, measures to reduce the interconnectivity of institutions and the "recovery" part of living wills; and

    — Measures to reduce the potential impact of a bank failure include the special resolution measures in The Banking Act 2009, equivalent arrangements for investment banks and the "resolution" part of living wills which will help ensure that in the event of failure the authorities can act swiftly and effectively.

  7.  Considerable progress has been made in the delivery of the reforms needed to strengthen the financial system. Banks are already holding more, better quality capital and liquidity, international agreement has been reached on a new capital and liquidity framework, and concrete steps are being taken towards achieving a regime in which no institution need be viewed as "too big to fail". This has been a collective effort and the UK banking industry has engaged fully. Against this backdrop it is difficult to see why the Government would wish to build such a high degree of autocracy into the regulatory framework.

STRUCTURAL WEAKNESS IN THE PROPOSED REGULATORY ARRANGEMENTS

  8.  The changes proposed within the Treasury paper relate specifically to the UK framework for financial regulation and are intended to overcome identified weaknesses within the tripartite regime. Whilst we would not disagree with the thesis that these arrangements failed in important respects during the early part of the crisis, so did those of many other countries. We would also note that the individual authorities have each contributed substantially to the banking reform programme and that many engaged in this have brought an expertise that is widely respected.

  9.  In terms of the "twin peaks" approach proposed within the Treasury paper, we can see ways in which the model can be used to ensure that appropriate emphasis is placed on both prudential supervision and conduct of business and therefore have no objections in principle. The model can clearly be made to work. But we have a number of fundamental concerns with the arrangements as proposed in the consultation paper. These are not inherent to the "twin peaks" model of regulation and can be corrected providing the shortcomings are recognised and there is a willingness on the part of the sponsoring authorities to make substantial revisions to their proposals.

  10.  As matters stand, we see a democratic deficit in the proposed structure, shortcomings in the proposed objectives for the various authorities, including insufficient alignment to the global and European environment, and the loss of proper due consultative process in comparison to the FSMA regime. We are also concerned about potential imbalances within the arrangements for the PRA and CPMA. We comment on each of these before turning to the specific questions raised by the committee.

INSUFFICIENT DEMOCRATIC ACCOUNTABILITY

  11.  It needs to be appreciated that in proposing the transfer of responsibility for prudential supervision to the Bank of England, the Government is not simply advocating a return to pre-1997 arrangements. At that time, the Bank was given independence over monetary policy—a powerful economic tool—and it has since been given responsibility for financial stability. The Treasury paper builds on this by setting out potential macro-prudential tools. This is in addition to the Bank becoming the lead authority for crisis management since under the new arrangements it will not only be the resolution authority, but responsible for the triggering of any special resolution regime.

  12.  When you consider the breadth of the Bank's new remit it is easy to see why many consider the proposed accountability to Ministers and Parliament to be undemanding. Accountability to Government Ministers for the activity of the FPC appears to be limited to the Governor briefing the Chancellor once every six months. Likewise, accountability to Parliament will rest with the FPC producing a six-monthly report for submission to the Treasury which will, in turn, lay copies before Parliament. Only in the case of crisis management and a possible call on public funds will the Governor be under an obligation to notify the Chancellor in sufficient time to ensure that all options can be considered and the Chancellor placed in a position to make the final decision on the use of public funds.

  13.  Few would argue with the need for a strong, independent central bank. In view of the broad responsibilities now being assigned to the Bank, however, we would see a greater need for a more interactive engagement between the Bank and the Government and Parliament. The six monthly reporting arrangements look lightweight. Whilst it may not be possible to develop the type of quantitative proxy for financial stability that can be set for monetary policy and the MPC, we would have thought that the involvement of Treasury Ministers in the work of the FPC should extend beyond the arrangements for the Chancellor to have the opportunity to comment on the risks in the system and the action being taken to address them. It is arguable, for instance, that prior approval should be required for the exercise of macro-prudential tools that may have significant socio-economic effect. We further believe that in drawing up the detailed arrangements we should foresee a need for a public debate about the significance that macro-prudential tools may have for households and businesses.

SHORTCOMINGS IN THE PROPOSED OBJECTIVES

  14.  The proposed intention is that the FPC and the authorities each be given a primary objective and for other factors to be expressed as secondary objectives or factors. While we can understand the need to give focus to each body, the approach proposed looks to us to be a major failing since it effectively detaches the respective bodies from responsibility for their actions.

The objectives of the FPC

  15.  If we take the FPC to begin with, paragraph 2.24 of the consultation paper proposes that its objective be to protect financial stability by:

    — Improving the resilience of the financial system by identifying and addressing aggregate risks and vulnerabilities across the system; and

    — Enhancing macroeconomic stability by addressing imbalances through the financial system eg by dampening the credit cycle.

  16.  It is recognised, in paragraph 2.26, that the use of certain macro-prudential tools "is likely to affect the levels of lending to businesses and families and the competitiveness and profitability of UK banks in relation to foreign competitors". The paper goes so far as to say that it will be important for the FPC to take factors such as these into consideration when pursuing its primary objectives. But the nearest we have to a commitment to the FPC being responsible for the consequences of its actions is an undertaking that the Government will consider whether the FPC "should be mindful" of these and other secondary factors when determining a particular course of action.

  17.  As discussed in the BBA's paper "A Possible Macro-prudential Approach",[15] the nature of financial stability is different to that of monetary policy and so we would not envisage the success or otherwise of the FPC being judged by reference to quantitative financial stability targets. The objectives for the FPC will need to be couched in much more general terms and its overall aim will be to ensure that the banking industry is better prepared to weather economic downturn. In the first instance, this will probably mean seeking to reduce the amplitude of economic cycles rather than attempting to prevent asset bubbles emerging, which may develop more over time.

  18.  One concern is whether specific reference needs to be made to the countervailing need to maintain economic growth. The pursuit of financial stability, by definition, involves constraining credit supply (and influencing demand) and there is a risk that, if poorly calibrated, measures pursued could have a disproportionate effect on economic growth. When combined with the focused nature of the objectives of the Monetary Policy Committee you can see that without some recognition of the benefits of economic growth as the means by which businesses and families can prosper then there is a real risk that the natural conservatism of the central bank may result in a significant imbalance in the macroeconomic management of the UK economy.

  19.  This therefore begs the question of whether there will be the means by which consistency and inter-connectivity between monetary, fiscal and financial policy can be achieved. Previously, the Tripartite Standing Committee provided that forum even if it appears that it was under-utilised in this regard. Under the new framework, fiscal policy is put to one side and the link between the MPC and FPC is embodied principally in the Governor of the Bank of England, with the Treasury afforded no formal role beyond "observer" status. It is difficult to see where aspirations for economic growth fit within the arrangements proposed.

  20.  Whilst we appreciate that international discussions on the nature of macro-prudential regulation are still at a relatively early stage, we believe that it would be helpful for the FPC's objective(s) to be set into the context of the European Systemic Risk Board and the way in which domestic measures would fit within the European and international framework.

The objectives of the PRA

  21.  The setting of the primary objective for the PRA is similarly misguided. Paragraph 3.5 of the consultation paper proposes that the PRA has a primary objective to promote the stable and prudent operation of the financial system through the effective regulation of financial firms in a way which minimises disruption caused by any firms which do fail. Factors which are reduced to a status of something that the PRA must "have regard" to include the principles of good regulation and "important matters which relate to the public interest". In fact, paragraph 3.10 goes as far as to say that the Government is seeking views on whether the PRA need be troubled by secondary considerations such as the importance of it using its resources in the most efficient and economic way or the principle that a burden imposed should be proportionate to the benefits which are expected to result. We find it a matter of some considerable concern that the question needs even be asked.

  22.  We further disagree with the conclusion that the failure of "light touch" regulation necessarily means that the prudential regulator should not be placed under an objective to maintain international competitiveness. As far as we are concerned, competitiveness is the lifeblood of the UK financial services marketplace and respecting the need to maintain a competitive edge provides a natural check and balance. Good regulation, as measured by international competitiveness, provides a counterbalance to ever increasing regulatory demands and encourages the presence of the best global institutions in the UK marketplace. It is difficult to see the justification for this being viewed so negatively.

  23.  We are also concerned with the proposed governance arrangements for the PRA. We are not convinced, for example, that it necessarily achieves the right balance for the PRA to be a subsidiary of the Bank and for the Governor to chair the authority. It would be interesting to understand the extent to which consideration was given to alternative arrangements, for instance, relying more on the provision of powers to the FPC to direct the PRA in the execution of macro-prudential tools. This would have avoided what may be an undue concentration of power within the hands of the Bank and permitted the specific responsibilities of the PRA for the micro-prudential supervision to have a clear identity without losing any of the benefits of setting micro-prudential supervision within a broader macro-prudential framework.

  24.  We would also question the proposition that the non-executive directors of the PRA be stood down collectively for decisions on significant regulatory or supervisory decisions concerning individual firms. This to our mind creates a two-tier board and results in a loss of perspective and experience that would result from the involvement of the non-executives in such decisions. Whilst, by definition, their involvement would involve addressing potential conflicts of interest, it should be possible to achieve this through a combination of the selection process and the ability for non-executives to excuse themselves as necessary from discussions.

The objectives of the CPMA

  25.  The same can also be said of the proposed objectives for the CPMA. Its primary objective will be to ensure confidence in financial services and markets, with a particular focus on protecting consumers and ensuring market integrity. This leaves the following expressed as secondary considerations, explicitly referred to as "have regards" in chapter 4 of the consultation paper:

    — the principles of good regulation;

    — the potential impact of policies or regulatory decisions on consumer and business lending; and

    — the need to maintain diversity in the financial services sector.

  26.  We are concerned about the CPMA being described as a consumer "champion". This, to our mind, has the potential of creating an imbalance in its objectives from the outset and also reinforces the concern that we have of the CPMA somehow being detached from responsibility for its actions. We would prefer therefore a description based more on the development of a marketplace in which consumers are provided with clear and understandable product information from which they can make informed choices. This involves placing consumers in a position where they can take responsibility for their financial decisions. The implication that the new authority will somehow become their advocate does not help this.

  27.  The objectives as expressed heighten our concern about the lack of due process to be built into the system. As far as we can see, the intention is that the bodies be exempted from the usual standards of consultative due process applicable to other arms of government and excused from any responsibility of the consequences of their actions on the wider economy and society.

  28.  We view the primary function of the UK Listing Authority in a market regulation light given its responsibility for overseeing consistency in disclosures and processes for listed securities. As a result, we believe that the UKLA should remain within the markets division of the CPMA as we see its function as integral to the regulation of the markets on which securities are admitted to trading. This would keep primary markets regulation and secondary markets regulation in the same place and enable a smoother transition to the new arrangements.

  29.  We see merit in the opportunity being taken to place responsibility for consumer credit in one place by transferring responsibility for regulated consumer credit from the OFT to the CPMA.

INSUFFICIENT EMPHASIS ON EUROPEAN AND GLOBAL INTERACTION

  30.  It is arguable that the objectives for the key bodies, and potentially aspects of the reorganisation, do not place sufficient emphasis on the inter-relationship between the bodies and the European and global financial infrastructure. In the case of the PRA and the markets division of the CMPA, large parts of their activity are governed by European directives and plans are in place for national rules to be superseded by mandatory European rules. It is therefore essential that the authorities give priority to representing the national interest in the relevant European authorities and for their activities to be organised in a way that creates natural "hubs" for the implementation of the new European rulebooks. It is disappointing therefore to see so little reference given to the European process in the Treasury paper.

  31.  We believe, in particular, that there would be merit in the responsibilities of the markets division of the CPMA mirroring those of the European Securities and Markets Authority (ESMA). For this reason, we would not view the potential transfer of responsibility for the UK Listing Authority from markets division to the Financial Reporting Council as being consistent with the need to ensure that the authorities be placed in a good position to represent the UK interest in European and international fora.

  32.  It is also the case that the FPC will, in some instances, need to take its lead from European and global bodies—whether the European Systemic Risk Board, the Financial Stability Board or the Basel Committee. Yet, again, there is scant reference to the European and global context in which it will work.

LOSS OF DUE CONSULTATIVE PROCESS

  33.  A great deal of time and care was taken with FSMA to establish the right balance between providing the prudential authority the scope to take necessary action to act upon regulatory shortcomings and the need for appropriate due process and consultation usually associated with changes to the rule of law. These processes are essential to the maintenance of market confidence in the regime in which financial institutions operate and are the bedrock of the type of certainty that institutions look for in determining where to locate business. This is as true an expectation for a UK financial institution as it is for the many overseas institutions that decide to locate financial services operations in the UK.

  34.  It is also the case that there are many instances in which consultation has proven an essential mechanism for identifying major unforeseen consequences in planned regulatory changes—a recent high profile example being the inadequate nature of the creditor protections within the Special Resolution Regime first proposed within the Banking Bill. It took a substantial effort on the part of the banking industry and the legal profession to persuade the tripartite authorities, including the Bank of England, that there were seismic shortcomings in the proposed arrangements. Due consultative process provided the time and opportunity to make the case for strengthening the inadequate safeguards which were maintained through many Parliamentary stages.[16]

  35.  In contrast, the Treasury paper makes clear that the authorities need no longer be bound by a commitment to due consultative process. Paragraph 3.22 in the chapter on the PRA explains that the Government "is considering whether the rule-making function should continue to be subject to statutory processes, including consultation with a practitioner panel, wider public consultation and the duty to carry out detailed cost-benefit analysis prior to the introduction of any new rules"; paragraph 4.23 in the chapter on the CPMA observes that similar considerations apply to the CPMA and, in addition, that the Government may enhance the own initiative variation of permission powers for the CPMA.

SPECIFIC QUESTIONS RAISED BY THE COMMITTEE

  36.  We would comment as follows on the overall issues raised by the committee:

Will the Government's financial regulation proposals improve the framework for financial stability in the UK? Will they work in a crisis?

  We believe that the proposed structure can be made to fit with the broader regulatory environment but see major shortcomings in the arrangements proposed and believe that unless corrected we could be preparing fertile ground for a future crisis.

Do the Government's proposals get the balance right between tackling the problems of the last crisis and preparing the UK financial system for the next one?

  No. We believe that there are fundamental shortcomings in the proposed arrangements and that these have the prospect of building in structural weaknesses of a different, but equivalent, nature to the identified failings in the current system that the Government is seeking to address. As explained above, the new arrangements are poorly defined in key respects and inexplicably autocratic. We see this as a significant failing in the proposals as set out so far.

How do the Government's proposals dovetail with initiatives currently being undertaken at European and the global level?

  We believe that a major theme for the assignment of responsibilities within the differing authorities should be their need to represent the national interest in European and global bodies. While recognised within the Treasury consultation paper, we do not believe that this has been given sufficient emphasis. This is evident in the order of priorities set out in the draft objectives for each of the authorities.

What costs will the regulatory structure place on consumers?

  This depends upon the nature of the macro-prudential tools handed to the FPC, the way in which the differing authorities work together and the awareness on the part of both the PRA and the CPMA of the extent to which their actions may change the supply of financial services. Unless identified issues are addressed we would consider there to be a significant risk of regulatory action bringing about unforeseen consequences for the price and availability of key financial services.

  37.  We would comment as follows in respect of the questions asked on power, roles and responsibilities:

Do the Government's proposals appropriately assign roles and responsibilities between the different regulatory institutions?

  Whilst the roles would appear reasonably well assigned, we fear that the proposed objectives will fail to instil appropriate responsibilities.

Will there be unintended consequences of the Government's proposals for regulation on the prospects for non-bank financial institutions;

  An unintended consequence of not achieving the right balance in regulation, including the deployment of macro-prudential tools in the regulated sector, may be flight to the unregulated sector and less heavily regulated jurisdictions.

  38.  We would comment as follows on the questions asked in respect of the Financial Policy Committee (FPC):

Should the FPC have a statutory remit? If so, what should that remit be?

  We believe that the remit should be qualitative in nature and modest at inception; based on an objective to moderate exuberance in economic boom years and enhance the resilience of the banking sector to economic downturn. We would agree that there is a need for this to be encapsulated in an appropriately defined statutory remit and would argue that this should be premised upon a need to balance financial stability with economic growth.

How should the success of the FPC, both in and out of crisis, be measured?

  Whilst the success of the FPC should primarily be measured against criteria born out of financial stability, such as dampening credit cycles and, at some future, stage, the avoidance of asset bubbles, we believe recognition should also be given to the generation of conditions suitable for sustainable economic growth.

Given the international regulatory framework, what macro-prudential tools should be granted to the FPC?

  The FPC should take its lead from any directives made by the European Financial Stability Board and others such as the Financial Stability Board or the Basel Committee. Should these advocate the adoption of clear, prescriptive macro-prudential tools, such as the introduction of a counter-cyclical capital buffer, then the FPC should act upon these without gold-plating. In other instances it may be that the FPC should recommend for Government consideration action based on the particular circumstances of the UK market. This for instance could at some point include measures aimed at addressing asset bubbles in particular sectors of the property market, whether buy-to-let or commercial. In these circumstances, however, it is unclear whether it would be for the FPC to act or whether it would be more appropriate for the committee to make observations which Treasury Ministers may wish to pursue in devising public policy initiatives or in making adjustments to government spending or fiscal policy.

Has enough been done to mitigate the risk of conflict between the FPC and the Monetary Policy Committee (MPC)? Is the FPC appropriately structured in terms of: the balance between internal and external members; and the size of the Committee?

  Whilst we support the creation of the FPC and believe that the role it has to play is of the magnitude of the MPC, we are not as yet convinced that sufficient thought has been given to their interaction. This said, we believe that it would be beneficial for the FPC to aspire to achieving an equivalent status to the MPC and consider that the two committees should be complementary.

  A membership based on five executive members and five non-executive members, plus the Governor of the Bank of England as Chair, would not seem excessive. Of course, it would mean that the FPC (in common with the MPC) will have "strong, credible external representation" (paragraph 2.39), but this will fall short of the expectation placed on UK corporates for a majority of board members to be independent, including the chair, and for this to be replicated for key board committees overseeing executive performance.[17]

What characteristics, experience and qualities should the Government look for when appointing external members of the FPC?

  While the FPC, as with any senior committee or board, will benefit from diversity within its membership, core characteristics must be independence of mind, financial experience and socio-political awareness.

  39.  We would comment as follows on the Prudential Regulation Authority (PRA)

Should the PRA be the lead authority over the Consumer Protection and Markets Authority (CPMA)?

  We would envisage that it is more the case that the PRA should lead in respect of prudential supervision and the CPMA in respect of consumer protection. Work should be undertaken to avoid "underlaps" and an attempt should be made to understand which will lead and in what instance in the case of overlaps.

Is it appropriate for the PRA (and CPMA) to adopt a judgements-based approach to financial regulation and supervision?

  Yes. The adoption of judgement-based supervision is about employing people of a caliber capable of questioning institutions about their strategy, business models and culture. This is more in keeping with the more macro-prudential view that is being put in place and has to provide the supervisor with a better means of understanding the real drivers of the business than a tick box approach to a detailed rulebook.

  40  We would comment as follows on the questions concerning the Consumer Protection and Markets Authority (CPMA):

Do the reforms provide adequate protection for the consumer?

  One of the arguments in favour of a "twin peaks' approach to regulation is that it allows regulatory responsibility for consumer protection to come out of the shadow of prudential supervision. Whilst we have no difficulty with this, we regard early references to the CPMA being the consumers' champion" as misguided. A more constructive positioning surely would be for the regulator to work in favour of fair and reasonable outcomes for consumers in which they take responsibility for the decisions they take and in which financial institutions commit to providing clear and understandable information on which to make those decisions.

To what extent will the regulatory and administrative burden increase for those firms who now have to deal with two regulators?

  There will clearly be cost and bureaucracy involved in having to deal with more than one regulator. The answer to this, we believe, is early consultation on a memorandum of understanding setting out the way in which the PRA and CPMA and others will interrelate. There may also be a case for some form of common services group to undertake such activities as licensing applications, regulatory permission changes, regulatory information requests and the collection of levies.

  41.  We would comment as follows on other issues identified:

Should any of the proposed bodies be given responsibility for promoting competition in the banking and financial services sector?

  We believe that the need is more for the authorities to be given responsibility for maintaining a competitive marketplace. This is sadly missing from the outline objectives set out in the Treasury consultation paper. We do not see a competitiveness objective as sitting on the opposite side of the scale to strong regulation and instead believe that it creates an obligation on regulators to consider the practical consequence of their actions. This is relevant not only in a domestic environment, but within the context of European negotiations where global imperatives are often seen as secondary to regional considerations. We find it highly surprising that the need for an international competitiveness test should not be readily understood as being in the national interest.

Should any of the proposed bodies have a role in promoting the City of London?

  We do not believe that regulators should have a promotional role as such. But we do believe that they should have responsibility for the maintenance of a competitive marketplace.

22 September 2010







14   Financial Stability Forum Action Plan April 2008; adopted by the G20 November 2008 Back

15   A Possible Macro-prudential Approach British Bankers' Association, March 2010 Back

16   BBA Parliamentary brief-Banking Bill, second reading, October 2008 Back

17   The UK Corporate Governance Code, June 2010; Walker Review final recommendations, November 2009. Back


 
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