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None of us who was in the FSA as the financial crisis intensified in autumn 2008 will ever forget that experience. I certainly won’t – becoming chairman of the FSA on Saturday September 20 2008, a week after Lehman had collapsed and two weeks before we decided we had to recapitalise and part nationalise significant parts of the UK banking system.
And the crisis made it crystal clear that the pre-crisis system of prudential regulation had been severely deficient in three important respects:
We have fundamentally changed both the regulation and supervision of individual banks. But regulating and supervising individual banks – or other individual firms or markets – is insufficient in itself to ensure financial stability. That requires, in addition, a focus on the overall financial system, and an ability to use what have come to be labelled ‘macro-prudential’ policy levers. That focus and those levers will now be the responsibility of the Financial Policy Committee (FPC) of the Bank of England.
Engagement with the work of the FPC, both in terms of input into its analysis and deliberations, and in ensuring implementation of its recommendations – many of which are made to the FSA – has been an important new activity of the FSA over the last year. And the creation of the FPC has already made possible a more integrated approach to crucial issues, which was impossible under the previous regime. In particular, in that respect I would highlight the FSA’s decision, announced last Friday, to amend our liquidity rules which govern how much self-insurance banks should hold against liquidity stress, in the light of the changes to Bank of England policy towards the provision of contingent liquidity insurance. The FPC debated carefully the way in which those different aspects of policy fitted together: such integration of policy was impossible in the pre-crisis regime.
These three sets of changes – regulation, supervision, and the macro-prudential approach – could have been introduced without any legal change in the FSA’s responsibilities. But the new government was committed to structural change, and once it is achieved I believe we will gain significantly from it. There are natural links between prudential regulation and central banking, closer than those between prudential and conduct regulation; and the division of the FSA into the Prudential Regulation Authority and the Financial Conduct Authority will enable each to focus on developing the appropriate and somewhat different approaches and skills required to identify and mitigate prudential and conduct risks. Implementing this change against a background of global financial stress is of course challenging. But we are confident we can implement the change without any loss of attention to current risks. And, once achieved, the new regime will deliver benefits.
The last year, on which we are reporting today, has been a crucial one in preparing for the structural change – indeed, a lot of the most important work has already been done. We have now divided our supervisory staff between prudential and conduct units. We have made good progress in working out how functions such as authorisations will work in the new regulatory structure and will pilot how ‘twin peaks’ will operate at the regulatory gateway later this year.
As all of you in this room involved in business know, this is a huge challenge, and in an ideal world we would have implemented all this in calmer times. But we are now well advanced with the required changes. We have moved already to what we call ‘internal twin peaks’ – i.e. to the internal division of the FSA between a prudential and a conduct business unit. The prudential unit, headed by Andrew Bailey, will become the PRA: the conduct unit, headed by Martin Wheatley will become the FCA.
Creating the new organisations will be an opportunity to put behind us the damaged reputation which the FSA suffered as a result of pre-crisis failings. A fair assessment of those failings would reflect a wider context – the inadequacy of regulations agreed by central banks and regulators across the world; and the intellectual delusions which left too many apparent experts blind to the impending disaster. But deficiencies in the FSA’s own approach played a part within that wider context – and the FSA has been more willing than any other institution to admit those deficiencies, to learn from them, and commit to and deliver the radical changes needed to put them right.
The new regulatory bodies to be launched next year – the PRA and the FCA – will build on what has been already achieved – both over the last year on which we are reporting today, and over the three or four or so years before that.