Financial Regulation

Written evidence submitted by the Chartered Institute of Bankers in Scotland

On behalf of the Chartered Institute of Bankers in Scotland, I am delighted to respond to the Committee’s Call for Evidence on the Government’s proposals to change the system of UK financial regulation, as set out in the July 2010 consultation paper. I hope you will find our comments helpful.

1. General Comments on Proposals

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

1.1 In our view, the proposals are helpful in improving the regulatory architecture. They should help improve both "early warning" of potential problems and more effective crisis resolution through better communication between the regulatory bodies. We believe these are necessary but not sufficient steps, however, in preventing future financial crises, as the regulatory changes alone will do little to improve the public confidence and trust in banks and bankers on which a sustainable banking industry must be built.

1.2 Rebuilding confidence and trust in banks requires, in our view, rebuilding confidence and trust in the integrity and competence of individual bankers, from Customer Service Officers to Chief Executive Officers. We need to bear in mind that not all the problems affecting the UK banking industry were imported from the US – poor lending decisions, poor risk management and poor liquidity management lay at the heart of the difficulties faced by institutions including Bradford & Bingley, HBOS and Northern Rock. "Better bankers" play as important a role in ensuring financial stability as an improved regulatory framework.

1.3 We would like to see, therefore, the new regulatory framework supported by further work to develop and embed a culture of professional integrity, founded on a common commitment across the industry to high ethical, professional and technical standards. This will require encouragement and support from government and regulators in the form of:

· Working with the banking industry and stakeholders to develop and agree set(s) of professional standards and monitor compliance with these – this could be supported by a Professional Standards Board or similar, along the lines of that suggested by the Future of Banking Commission;

· Introducing and monitoring requirements for some form of initial and ongoing ethical and professional training for those employed in the banking industry;

· Introducing a requirement for senior staff and supervisors to positively encourage the development of higher ethical, professional and technical standards within their firm; and

· Working with professional bodies and others to raise professional standards across the industry.

1.5 We are unsure that the totality of risk in the financial system is being fully measured or understood by regulators and institutions. Identifying potential, systemic risks and taking timely action to avoid these is, in our view, the key to ensuring the success of the proposed framework. This will require financial institutions and regulatory bodies to recruit and train greater numbers of more highly qualified banking and risk professionals than now.

2. Financial Policy Committee (FPC)

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

2.1 The main structural weakness in financial regulation was the division of responsibilities between the Bank of England and the FSA, and we believe the creation of the FPC would address this defect.

2.2 The FPC should have ensuring financial stability as its sole objective. Whilst factors such as the effects of the FPC’s actions on business and consumer lending, UK competitiveness and bank profitability are important, we believe these are secondary, political concerns that should not deflect the FPC from a clear remit to ensure stability.

2.3 We are concerned, however, as to whether the proposed Financial Policy Committee (FPC) – or any such body – will, in practice, be able to "identify imbalances, risks and vulnerabilities … and take decisive action" (i.e. be able to predict the next crisis); the majority of economists and regulators seemed unable to predict this one.

2.4 We propose that financial institutions’ Chief Risk Officers are included in the new regulatory framework, perhaps as an Advisory Panel to the proposed Prudential Regulation Authority (PRA), to ensure the early capture of potential systemic risks. This could help the PRA and FPC better predict, prepare for and prevent future crises.

3. The Prudential Regulation Authority (PRA)

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

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

3.1 We believe it is appropriate for the PRA to be the lead authority over the CPMA. Furthermore, we believe that the conduct of business by firms and individuals should be the responsibility of the PRA rather than the proposed CPMA, or that there should at least be some form of joint responsibility. "Unsafe" business practices such as lending without proper controls are not simply consumer protection issues but rather issues that – as we have seen – can threaten the stability of institutions and the system as a whole.

3.2 We strongly support the adoption of a judgments-based approach to regulation and supervision and believe this should prove effective provided:

· Institutions and regulators can recruit and train the requisite numbers of qualified, experienced banking and risk management professionals able to exercise professional judgement – this will require major changes in the way financial institutions and regulatory bodies recruit and develop their staff;

· General principles of prudent banking underpin the judgments-based approach, rather than prescriptive formulae such as, for example, a maximum loan-to-value (LTV) ratio – bad lending decisions can as easily occur at 60% LTV or 90% LTV; and

· Regulators take steps to embed the culture of professionalism required to support a judgments-based approach to regulation, without which institutions may try to game the system and push principles too far.

4. Consumer Protection and Markets Authority (CPMA)

Do the reforms provide adequate protection for the consumer?

4.1 Ensuring adequate consumer protection requires more than regulatory reform and the creation of new agencies. Only the development of "better bankers" at all levels, committed to high ethical, professional and technical standards will embed the culture of integrity and trust that is needed to demonstrate that the industry is truly "treating customers fairly."

4.2 The FSA’s "Retail Distribution Review" (RDR) offers a good example of how the financial services industry can work with regulators to improve professional standards and ensure better outcomes for consumers. The RDR applies only to the relatively small, retail investment advice sector, however. In our view, similar professional standards need to be applied across the whole financial services industry.

4.3 There is strong public support for this view. 88% of the public believe that all bankers should be required to take professional banking exams to demonstrate their competence and their commitment to professionalism1. Introducing new requirements for greater numbers of financial services personnel to hold a relevant qualification and to demonstrate an ongoing commitment to high ethical, professional and technical standards through continued education would do more, in our view, to improve outcomes for consumers than a change in the regulatory architecture.

4.4 We do not believe it would be helpful or practicable to require all individuals employed in the financial services industry to hold a specific financial services qualification, however. Many individuals employed in the industry perform non-financial services related roles and would not find such qualifications relevant.

4.5 Even if there is little appetite from regulators to impose professional qualification requirements, more could be done to encourage financial institutions themselves to embed higher ethical, professional and technical standards. This could include, for instance, a requirement for institutions to report to the regulator the numbers of staff (particularly those in Significant Influence and Approved Persons functions) holding recognized qualifications.

5. Other Issues

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

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

5.1 We believe it might be helpful for all the proposed bodies to be given a general (secondary) objective to promote competition in financial services, but that financial stability considerations must always override this where there is any conflict. In particular, the CPMA could play an important role in encouraging new entrants to the retail financial services sector, and in fostering competition.

5.2 We do not believe that any of the proposed bodies should have a role in promoting the City of London (as national bodies they would in any case presumably promote UK financial services, rather than the City alone). There are already a plethora of government, industry and other bodies promoting UK financial services and encouraging inward investment, and there is no need for the regulators’ integrity to be compromised by encouraging them to act as a form of marketing agency for the UK financial services sector.

5.3 In a similar vein, the new Consumer Financial Education Body (CFEB) already exists to promote public understanding of financial services (many other bodies also undertake work in this area) and there is no need for the CPMA also to work in this area, as proposed.

September 2010