04 January 2008

FSA to get power to shut failing banks

The main City regulator will be given powers to shut down and restructure failing banks as part of a wide-ranging package of measures designed to avert a repeat of the Northern Rock debacle.

Rules allowing the Financial Services Authority (FSA) to step in and take control of banks in financial difficulties will be combined with an enhanced deposit protection scheme that will not only guarantee a higher level of savings, but also promise to repay savers promptly.

Ministers are understood to believe the reforms will provide a robust defence against a similar run on a bank and answer critics who argue the entire regulatory system for banks was shown to be flawed.

Several MPs have expressed concern that the government's handling of Northern Rock's near collapse was undermined by the tripartite system of regulation that brings together the FSA, the Treasury and the Bank of England.

Some argued that bank regulation should be handed back to the Bank of England, which would take the lead when a bank was found to be in difficulties. Questioning by MPs revealed that the government was already considering reforms before Northern Rock was rescued in September by a government deposit guarantee and a loan, which is now estimated to total £26bn.

The chancellor Alistair Darling told the Financial Times he believed the tripartite system needed to adapt to changing circumstances rather than be disbanded in favour of a single regulator. He said: "I want to make sure our own legislation is up to the mark in dealing with problems when they arise in future." A consultation document outlining the reforms is due next month and will be followed by legislation in May, he said.

The scheme mimics the US system where an independent Federal Deposit Insurance Corporation has the power to override company insolvency laws and seize bank assets or execute a rescue. It can also distribute deposits to savers within days or weeks of a collapse.

In the UK, banks are governed by the insolvency regime which gives power to creditors rather than regulators in the event of a collapse. The current financial compensation scheme can also take more than six months to repay depositors.

The moves over regulation came as the Bank of England warned yesterday that the supply and price of credit to both businesses and households has already tightened and the situation is likely to get worse in the early months of this year.

Its latest credit conditions survey also showed that mortgage defaults are likely to increase. More than a million borrowers will come off cheap fixed-rate deals this year and will face higher interest rates. The survey showed lenders saying that the amount of secured credit they had made available to consumers in the fourth quarter had "reduced materially" as a result of the global credit crunch which almost brought down Northern Rock.

Crucially, banks said they expected the situation to continue or worsen in the first three months of 2008. Firms also reported that they were suffering the effects of tighter credit, with the availability of borrowing down "significantly" during the past three months.

Economists said the survey showed that the Bank of England's monetary policy committee had been right to cut interest rates last month. Several urged it to act again when it meets next week.

© Graham Bishop