On Wednesday 8th July 2009, Alistair Darling chancellor of the exchequer presented a government white paper outlining reform for the regulation of financial markets and banks in the UK. The paper follows on from the Turner report released in March of this year, and endorses many of its recommendations. The paper has received mixed reactions from members of the industry; some are welcoming the reforms as a solid first step, while others dismiss them out of hand, based on assumptions that most of the initiatives will be wiped out before they begin, by a Conservative Party victory in the upcoming general elections.

Changes to be made  

The main discussion revolves around the following points of Mr. Darling’s paper:

  • The creation by statute of a new Council for Financial Stability, by merging of the standing committees from the FSA, the Bank of England and the Treasury. The minutes of the Council’s meetings are to be published. It is hoped that the resulting increased scrutiny will drive the Council to lay out positive action to initiate reform, forcing the banks to either comply with the measures or to account for their failure to do so.
  • Empowering the FSA to require banks to hold more capital, in order to act as a buffer against losses. An interim regime overseen by the FSA is in place to guard against trading book capital risk-taking until 2010, when a comprehensive review to create a counter-cyclical capital regime will take place, as detailed in the Turner Review.
  • Requiring banks to have increased liquidity so as to ensure they can carry on business and fulfil their obligations at all times. This will involve the creation of a qualitative and quantitative framework for liquidity risk management, which will focus on the policies put in place to assess and tackle risk by the banks.
  • Empowering the FSA to introduce a “backstop” in order to prevent banks’ levels of borrowing from rising too high. A maximum gross leverage ratio will be introduced to guard against the risk of system-wide financial instability and the potential under-estimation of risk.
  • Adjustment to the Financial Services Compensation Scheme: a requirement that banks should retain enough finance to cover compensation schemes for their clients in the event of a future failure, in other words to be able to deal with a collapse themselves. This change of approach has been dismissed by the City as impractical, potentially freezing large amounts of bank assets unnecessarily, as a bank which fails completely is likely to need government aid in any event.
  • Country-wide education of consumers, to begin in the classroom, so as to reduce the public’s fundamental misunderstanding of risk.  

Mr. Darling emphasised the important role to be played by a co-ordinated international response to the changing regulatory framework. It is crucial that changes to the UK’s regime do not pull ahead of the international curve to the extent that business is driven way from the country.

Also to be considered is the EU’s financial reform agenda, which will try to harmonise regulation across member states.

Industry Response to the Reforms  

Criticisms of the paper include the fact that the timeline for implementation will outstrip the term of the current government, and that a likely Conservative Party victory would render many of the measures moot. Sweeping EU reform of capital and liquidity regulation will provide more structure, and perhaps eclipse the white paper measures, which have been condemned as being too vague. Conversely, the paper focuses in some detail on reform which will benefit the consumer, an approach which distracted from the regulation of the wider banking industry over the last decade.

The Bank of England has cautiously welcomed reform, but considers the tool of public scrutiny in the Financial Services Compensation Scheme “a blunt instrument”.

Industry experts have called for the chancellor to expand on the practical workings of macro-prudential regulation, which they say the current paper fails to do.