On Monday 3 November 2008, Rt Hon Alistair Darling MP, Mervyn King, Lord Turner of Ecchinswell, the heads of the tripartite authorities, answered questions posed by members of the Treasury Select Committee, chaired by John McFall, as part of the Committee’s inquiry into the banking crisis.  

The general impression and who asked what

Perhaps as expected, nothing controversial was revealed by the three heads who, at all times, presented a united front in relation to the questioning. Most of the questions were addressed to the Chancellor who, it seems, took the meeting as an opportunity to reiterate the reasons for the Government’s intervention in the banking crisis and gain the tax payers’ support for the terms of the bank rescue package.  

The three heads maintained a “business as usual” attitude and at this stage, it does not seem that the authorities intend to take any drastic action in relation to financial institutions.  

On the whole, although none of the questions seemed particularly probing, it was undoubtedly the Conservative members of the Committee, Michael Fallon and Graham Brady, who asked the more polemic questions of who is to blame and whether bonuses were still going to be paid in banks subject to the bail out plan. Labour MPs focused on the better known areas of general public concern, with Nick Ainger, inquiring about the measures that the government has put in place to guarantee that the tax payers’ money did not end up with the shareholders of the banks receiving state aid, and Sally Keeble questioning the role of the ratings agencies and the need for these to be regulated in the future. John Thurso of the Liberal Democrats was concerned with the well-publicised competition issues surrounding the proposed HBOS and Lloyds TSB merger and a fellow Liberal Democrat, Colin Breed asked about the FSA’s failure to regulate Northern Rock.  

Reading between the lines: the highlights

Despite all the political rhetoric, it has been possible to gain some interesting insights into both the Treasury’s and the FSA’s thinking.  

Who is responsible and what are the consequences?

The Chancellor was very careful not to assign responsibility to the FSA for failing to avert the banking crisis in the UK. Both the Chancellor and the FSA only went as far as accepting responsibility to the level that other regulators globally failed to see and regulate the risks that were developing.  

Lord Turner explained that with hindsight, the regulators concentrated all their attention on the domestic sphere and failed to achieve international cooperation, which is clearly necessary since the international markets are now very closely linked. He suggested the need for greater cooperation between regulators in the future, especially since new players such as China and India are now joining the global marketplace for financial products.  

The Chancellor also made a comment that the “catastrophic consequences” came about as a result of actions of middle managers in banks and the investment strategies that they pursued once equipped with high liquidity. In his opinion, the banks’ boards should serve as a line of first defence in trying to prevent banking crises. Consequently, the FSA is aiming to increase the quantity and quality of its supervising and scrutiny of the banking sector as part of its previously announced Supervisory Enhancement Programme.  

The new rules

Lord Turner also highlighted the need to draw up a new rulebook in relation to levels of capital required by banks that would serve as buffers in turbulent times, the need for regulating liquidity, which has previously been overlooked and developing ways for tackling counter-cyclical capital requirements both domestically and as part of the Basel process. Lord Turner accepted that this work will take time and did not suggest any time frames.  

In relation to the regulation of OTC derivatives, Lord Turner mentioned that the FSA has been discussing the need for a central clearing house for CDS, which would provide a greater risk transparency in relation to this product.  

Regulation and the rating agencies

In general, Lord Turner seemed to favour a non-intervention approach, where market forces could operate, such as in relation to the regulation of rating agencies. Although, he did not wholly reject the idea of regulating rating agencies, the Chairman of the FSA nonetheless suggested that it was possible that the markets would drive the changes in this sector, whereby people would simply stop buying the products and services of the rating agencies if these are deemed ineffective.  

The question of bonuses

There was no mention of setting limits on bonuses. According to Lord Turner, the FSA intends to continue analysing bonuses in the normal way, although it could require banks to reflect bonuses in higher capital requirements if necessary. However, the FSA is intending to review the structure of remuneration payments set by banks as it has set out in its Dear CEO letter of 13 October 2008.  

The role of non-executive directors

Although Lord Turner acknowledged the need for non-executive directors to invest adequate time and effort in their duties, he rejected the proposal for non-directors gaining some sort of special authorised status. In Lord Turner’s opinion, it is better to focus on more robust liquidity policies and better systems of managing counter-cyclical capital requirements in order to prevent overall systemic failures.  

What next?

As part of its ongoing inquiry into the banking crisis, the Treasury Select Committee has announced that it will hold two further meetings on 11 and 18 November 2008 in relation to accounting issues and the performance and actions of the recently nationalised Northern Rock and Bradford & Bingley respectively. It has also announced plans to schedule a hearing into the incentive structures (including remuneration policies) within financial institutions, and their potential effects on financial stability, both at the institutional and system-wide level at a later date. The three heads of the tripartite authorities are expected to return to give more evidence early in the New Year as the inquiry progresses.