The FSA has published a speech by Verena Ross (Director of Strategy and Risk) entitled Lessons from the financial crisis.
In her speech Ms Ross, focuses on three questions:
- Did the financial crisis represent a failure of regulation? Is it reasonable to say in hindsight that regulators in Europe and the US were negligent in not preventing the financial crisis? Here Ms Ross begins by saying that the FSA has openly admitted that it made mistakes in the institution specific supervision of Northern Rock. She then discuses two failures:
- Firstly, the FSA’s failure, along with other regulators and central banks, to identify that the whole financial system was subject to market wide, systemic risk. Regulators and central banks were focussing too much on the institution-by-institution supervision of risk. To prevent this from happening again Ms Ross states that there needs to be more sectoral analysis. There needs to be an integration of macro-economic analysis with macro-prudential analysis and information from micro-prudential supervision.
- Secondly, that there was a flawed set of prudential rules particularly for capital and liquidity. Ms Ross states that there needs to be a new approach to the regulation of the capital adequacy of banks. This ultimately means that higher levels of bank capital will be required, and in particular more capital required against trading books and the taking of market risk. The procyclical nature of the Basel 2 risk-sensitive capital measures also need to be addressed. Ms Ross also advocates that there should be an international requirement that banks build up substantial capital buffers in good economic times.
- Are the leading financial institutions too large and complex to be managed or supervised effectively? Ms Ross acknowledges that the FSA and other regulators placed too much reliance on market self correction, effective market discipline and that management and boards are best placed to identify business system risks. She then discusses the FSA’s more intrusive approach to supervision which will place a greater emphasis on outcomes testing.
- International coordination and its impact on the international financial markets. Ms Ross states that the financial crisis has highlighted significant shortcomings in the international regulatory framework. In particular, Ms Ross states that the failure of the Icelandic banks has demonstrated that current arrangements, in particular the current home/host framework of sharing supervisory responsibility are unsustainable. She then briefly discusses the options for change that Lord Turner suggested in his review, being 'more national powers' or 'more Europe'.
View FSA speech - Lessons from the financial crisis, 24 March 2009