FSA has just announced plans to extend its conduct of business regime for retail banking services, to deposit-taking in particular. This article looks at its proposals and the reasons behind them.

The Financial Services Authority ("FSA") has published a consultation paper on a proposed new framework for regulating retail banking conduct of business, especially deposit-taking.

The FSA considers the enforcement powers of the Banking Code Standards Board ("BCSB"), which operates the current regime of voluntary "Banking Codes", to be inadequate. The FSA is no longer prepared to leave the conduct of deposit-taking business largely to self-regulation.

In this article Robert Finney and Dominic Gilmore look at the details and the likely outcome of the proposed framework. 

What are the current arrangements and what are the FSA's concerns with them?

The FSA is the statutory authority responsible for deposit-taking, yet has few rules governing the conduct of deposit-taking or electronic money business – typically only where required to do so by European law. For those few FSA rules that do apply, monitoring tends to be carried out by BCSB on the FSA's behalf.

Typically, the FSA will take enforcement action for breaches in this area only where there are prudential implications. Critically, this means some of its Principles for Business are, in effect, of limited application – in particular Principles 6 (Customers' interests) and 7 (Communications with customers) which embody the FSA's expectations on treating customers fairly.

Instead of FSA regulation and supervision, the industry has regulated itself by means of the Banking Codes to which virtually all retail banks and building societies subscribe. The Codes cover deposits, overdrafts and personal loans, cards and other services. BCSB monitors compliance.

The FSA thinks the scope of the Codes is broadly correct and BCSB monitors them effectively. But it has some concerns about the present arrangements:

  • the current approach is less principles-based and transparent than the FSA's approach; 
  • BCSB cannot fine for breaches, which hinders deterrence (it can only issue a public censure or expel the firm); 
  • there are gaps in the Codes' content, such as the lack of an overarching fairness objective; and 
  • implementation of the Payment Services Directive ("PSD") on 1 November, 2009 (which provides conduct of business rules for payment transactions and for which the FSA will be the main supervisor) will replace much of the existing Codes.

What will the new framework involve?

The FSA proposes:

  • full application of its Principles for Business to the regulated activities of accepting deposits and issuing e-money; 
  • new high-level rules applying to retail banking services outside the scope of the PSD in a short, new Banking Conduct of Business sourcebook ("BCOBS"). These rules would support the Principles and would include all existing FSA rules that apply to deposit-taking business; and 
  • FSA monitoring and enforcement of compliance.

Application and content of BCOBS

BCOBS is designed to protect "banking customers" who are:

  • consumers (individuals not acting in the course of business); 
  • micro-enterprises (employing fewer than 10 people with a turnover/balance sheet of less than €2 million); 
  • a charity with an income of less than £1 million per annum; and 
  • a trustee of a trust with a value of less than £1 million.

In principle, the FSA will apply BCOBS not only to UK banks but also to UK branches of credit institutions authorised in other EEA states.

The content of BCOBS will be restricted by the broadly "maximum harmonising" nature of the PSD. Conduct of business requirements for payment accounts will be in the UK Government's Payment Services Regulations, not in FSA rules and guidance.

BCOBS would apply to "retail banking services", a new term covering both accepting deposits and providing services in relation to deposits (e.g. cheques and foreign exchange services). It would not apply when the service is within the scope of the PSD and subject to the harmonised requirements. Nor would it apply to any lending activities – consumer credit will remain a responsibility of the Office of Fair Trading ("OFT").

BCOBS would apply fully to non-payment accounts (such as cash deposit Child Trust Funds and all accounts denominated in accounts other than sterling or euros). For payment accounts, BCOBS would apply where PSD rules do not (for example, the BCOBS rules on financial promotions and moving a retail banking service).

Transfer of existing FSA rules to BCOBS

Relevant rules already in FSA Rules, mainly in COBS, would be transferred into BCOBS. These include rules on:

  • communicating with clients; 
  • distance communications; 
  • key disclosure requirements for cash deposit ISAs and Child Trust Funds; and 
  • cancellation (these rights would be extended to reflect the Banking Codes).

New rules in BCOBS

The new areas covered by BCOBS would mainly relate to information to be provided to banking customers and post-sale requirements. Their content largely reflects that of the Banking Codes and would include:

  • information on matters such as the firm, the types of services offered, the terms and conditions of the services, interest rates, costs and charges, complaints and compensation; 
  • the provision of regular statements for non-payment accounts where appropriate; 
  • the provision of a prompt, efficient and fair level of service; 
  • the fair treatment of customers in financial difficulties; and 
  • a prompt and efficient service to enable a customer to move to a retail banking service provided by another bank.

Monitoring and enforcing compliance with the Principles and BCOBS

Monitoring the conduct of retail deposit-taking activities will fall within the FSA's overall approach to the supervision of regulated firms. As with other areas, the FSA would apply a risk-based approach, factoring in new risks arising from the conduct of deposit-taking. The FSA says it will be focussing more on achieving desirable customer outcomes than on adherence to detailed conduct of business rules that say how to achieve the outcomes.

Similarly, enforcement of BCOBS rules will mirror the FSA's general approach. This is quite different from the approach taken by BCSB: for example, the FSA's investigation and enforcement process is different, the threshold that must be reached for disciplinary action to be taken is lower, it can impose fines for breaches, and it can take disciplinary action against individuals as well as firms.

Note that the Financial Ombudsman Service already has jurisdiction to consider complaints relating to banking business.

Why is the FSA really doing this?

This initiative appears to reflect the FSA's increasing aversion to self-regulation. Influenced in large part by recent turbulent market conditions, the FSA is no longer content to defer regulation of business conduct in relation to deposits to the banking industry itself. Nor is it content to rely on BCSB's powers of deterrence which it views as a blunt instrument.

This is despite BCSB's assertion that the voluntary nature of the existing Banking Codes means that firms willingly sign up to them and are generally committed to following them. BCSB also argues the Banking Codes are flexible in nature, which allows changes at short notice.

The FSA's proposal also reflects the fact that, in other areas of retail finance (like mortgages and insurance), it has stepped up enforcement in its Treating Customers Fairly programme, and is hammering home the principle that customers be given sufficient information which is clear, fair and not misleading. For example, in July of this year, Liverpool Victoria was the subject of enforcement action for failing to treat its customers fairly (amongst other things) when selling payment protection insurance to them.

The proposals also reflect the FSA's belief that it would be anomalous for it to regulate payment transactions under the PSD whilst leaving another part of financial services to voluntary self-regulation. Arguably, to regulate payment services but not deposit-taking would confuse consumers.

What practical changes will banks have to make?

The full application of the Principles (especially Principle 6) is unlikely to require a sea change in behaviour for most deposit takers. All firms must already comply with the Unfair Commercial Practices Directive's prohibition on treating customers unfairly. The Banking Codes' fairness commitment covers the same ground. The Financial Ombudsman Service determines cases brought before it on the notion of what is "fair and reasonable". The FSA has stated that many Banking Code subscribers already seek to apply Principle 6 across their retail banking business. So most affected firms will already be operating with the concept of "fairness" in mind.

Does the possibility of a fine from the FSA provide any compliance incentive? For most affected firms, a fine is not in itself a particular concern – although some large fines have been levied in recent years. Rather, bad publicity (the threat of public censure and attendant reputational damage) carries much more weight. BCSB already has this weapon and has used it, for example against Sygma Bank in 2004.

Arguably, BCOBS itself is superfluous because the FSA can achieve almost all it needs just by applying its Principles to deposit-taking and enforcing them. It is not obvious that statutory regulation by the FSA will bring customers any practical benefits, although it will perhaps increase customer confidence in these turbulent times. That said, none of the proposed rules would have made a real difference to the risks to which retail depositors have been exposed for the last 15 months.

One area where BCOBS could have more significant impact, however, is on providers of deposit products linked to equity or other indices. These fall outside the scope of the burdensome regulation applicable to contracts for difference and similar "investment" products. Consumers are often confused by exactly what terms apply, and some may "purchase" quite unsuitable products. Whilst BCOBS and the Principles might force firms to provide better product information, the FSA states that Principle 9's concept of suitable advice will be of less relevance to deposit-taking than other activities – perhaps they have yet to consider index-linked deposits.

The proposed reform (but not the FSA's consultation paper) raises two more questions: what happens to the residual business of BCSB, and should consumer credit regulation be transferred to the FSA. The BCSB will continue to oversee unsecured loans and credit cards, so statutory and self-regulatory remits could be unnecessarily confused. Likewise, how will the new rules sit alongside the existing OFT framework of consumer credit regulation and its work to regulate bank charges? The FSA and OFT already have a cooperation agreement, and a decision not to move consumer credit regulation from the OFT was taken several years ago. However, the regulators acknowledge that increased cooperation will be necessary.

How big an extension of the FSA's regime does this reform represent? The firms that will be covered by the full application of the Principles and BCOBS are already authorised by the FSA and at least subject to its prudential supervision. So they will suffer only an extension of the FSA's business oversight and enforcement rather than the application of a wholly new regulatory regime.

What next?

The FSA seeks responses to this consultation by 16 February 2009 and proposes to implement the changes on 1 November 2009 (at the same time as the Payment Services Directive comes into effect).