The debate is healthy and needed. Many will have their own ideas of how well the FSA has done since 1999 when it began to regulate the financial services industry. But before reaching any conclusions about the future of the FSA, there should be a thorough investigation into what has gone wrong and why and what part the FSA has played. Ideas for reform should be based on a proper understanding of the facts.
The facts relating to a few of the big events since 1998 are not reassuring.
Take first the failure of the prudential regulation of Equitable Life. There is a detailed account in the excellent report by the Parliamentary Ombudsman, Ann Abrahams, published in July 2008. The title, Equitable Life: A Decade of Regulatory Failure, gives a flavour of its conclusions. The decade in question was the 10 years before December 1, 2001.
On January 1, 1999, the FSA took on most of the functions and powers of the Treasury relating to the prudential regulation of insurance companies. Thus, the FSA was responsible for only the last three years. But the ombudsman made five findings of maladministration against the FSA during that time.
To put that into context, in respect of the whole period she looked at, she made 10 findings. The FSA was responsible for half of them.
Shortly after Equitable closed to new business, the FSA’s internal audit department carried out an inquiry into the FSA’s performance. It concluded that the FSA could have done better in crucial respects.
For example, the report concluded that the prudential regulation of the insurance companies was less intrusive and involved compared with the regulation of banks.
The report recommended that the FSA should “be prepared to act more proactively…to ensure that the interests of customer are properly protected”. In other words, the FSA should take action when necessary to protect customers.
Next: Northern Rock. One of the reasons for its failure was its flawed business plan – it was borrowing short and lending long. That was, of course, a management failure.
Once those concepts of borrowing short and lending long had been explained to the man on the top of the Clapham Omnibus, he could well have said, “Blimey, that sounds a bit dodgy, doesn’t it?”
Again, the FSA’s internal audit department carried out an inquiry and issued a report which concluded that the FSA should have done better. On the same day as the principal conclusions of that report were published, Hector Sants issued a response in which he said: “As we have already made clear…the failure of Northern Rock should first and foremost be attributed to the failure of its board and executive to create a durable funding model which could withstand the exceptional set of market circumstances that occurred in summer 2007.
“Nevertheless, the FSA acknowledges that its supervision of Northern Rock…was not of sufficient intensity or appropriate rigour to challenge the company’s board and executive on their risk management practices and their understanding of the risks posed by their business model.”
In other words, there was no proper challenge and a failure to take appropriate action.
Look at HBOS. As a result of the recent disclosures made by Paul Moore, the ex-head of regulatory risk at HBOS and the so-called HBOS whistle-blower, the FSA felt compelled to issue a statement on February 11, 2009. It speaks volumes about the FSA’s own performance as well as that of HBOS.
The FSA said that it had carried out a full risk assessment of HBOS in late 2002, in which “it identified a need to strengthen the control infrastructure within the group”.
Another risk assessment followed a skilled person’s report in 2004 and the FSA concluded “that the risk profile of the group had improved…but that the group risk functions still needed to enhance their ability to influence the business…”
After Paul Moore’s dismissal at the end of 2004, the FSA continued to pursue its concerns, and wrote to HBOS on June 29, 2006 (that is, about 18 months after Mr Moore’s dismissal) with yet a further risk assessment.
The FSA’s letter said that there were still control issues and that it would closely track progress in this area. In its letter, the FSA added that “the growth strategy of the group posed risks to the whole group and that these risks must be managed and mitigated”.
Not long afterwards, HBOS failed. That statement begs the question of what steps the FSA itself took to ensure that the risks to the whole group were indeed managed and mitigated and why, if the FSA did act, did HBOS fail?
The answer might well be, as with Equitable Life and Northern Rock, there was no proper challenge of the management and a failure to take appropriate action.
There has been no published report of an inquiry into the HBOS affair. There ought to be. It ought to look at not only the performance of the FSA but also what was going on in HBOS and elsewhere.
The case for a thorough inquiry is overwhelming. Why has the banking system failed? Why did the FSA fail to make any perceptible difference in the cases of Equitable Life, Northern Rock and HBOS? What happened at the Royal Bank of Scotland and what did the FSA do about it?
Is the FSA’s problem that the rules need to change? Or is the problem its strategic approach – principle-based and outcome-based regulation? Or its culture – still light-touch?
Is it a lack of well-qualified, experienced individuals with the personal qualities to stand up to CEOs such as James Crosby, who was also a non-executive director of the FSA at the time?
Why did the respective executive managements embark on actions which resulted in the failures of Equitable Life, Northern Rock, HBOS and RBS? Were the audit committees of the boards on top of the issues and risks? If not, why not?
Where were the risk managers? What were they saying and doing, and why were they not getting proper support internally from the firms and externally from the FSA?
Should the banks be split into retail banks which are highly regulated, and less well regulated “casino” trading investment banks, as suggested recently by the governor of the Bank of England? Should there be an external body to hold the FSA to account, with appropriate powers to put things right and award compensation to those who have suffered loss? If not, why not? The questions go on and on.
One thing is clear – the FSA has failed again and again in crucial areas so it should not be left – yet again – to devise its own way forward. Lord Turner’s recent report and the imminent report by the Treasury select committee should both be treated as contributions to the debate.
But there should be a commission of inquiry with all the required skills and experience to assess the facts, apportion responsibility and propose a coherent way forward. It is now 25 years since Professor Gower’s report which led to the modern era of regulation – it is time for a thorough review.