The final report of the Parliamentary Commission Banking Standards attracted headlines mainly due to the proposal to jail bankers guilty of a new offence of reckless misconduct in the management of a bank. In many other respects, the 571 page report contained relatively few surprises. This itself is perhaps unsurprising given the plethora of reviews into banking and regulatory failures which have preceded it over the past four years and the work done by the regulators to address some of the perceived shortcomings. What is clear, however, is that not all the blame can be laid at the door of the banks. There are plenty of lessons for the regulators, lawyers, auditors and even politicians themselves. Instead of just focusing on the most recent financial crisis, a broader historical perspective is needed.
In a speech delivered in 2001 Sir Howard Davies, the first Chairman of the Financial Services Authority, described the creation of the new regulator as “a starting point, not a destination”. The intervening dozen years have certainly been a bumpy ride for both the regulator and the financial community that it regulates. However, we have of course been there before. Between “Big Bang” in 1986 and end of the last century, UK banking regulators had to deal with their fair share of crises, not least the collapse of BCCI in 1991 and then Barings Bank four years later.
Steady as she goes
Rather than question the principle of deregulation, back in 1997 the incoming Labour government merely redesigned the regulatory structure, creating the FSA in an attempt to concentrate supervisory responsibility in one single regulatory body. Yet, for the majority of firms, their experience of the regulatory system after December 2001 was remarkably similar to that prior to the reform. The expectations of regulation had not fundamentally changed.
The system was designed to encourage risk taking and make the City a magnet for international business. As Ed Balls once put it “If the City is doing well, we are all doing well. When it prospers, we all prosper”. The culture of light touch regulation created the expectation of a stable and predictable regulatory environment. Against this background the FSA sought to develop a fair, proportionate, predictable and increasingly risk-based system.
Expectations of the regulatory system
Yet, the deepening onset of the financial crisis in 2007 gave rise to a marked shift in the public’s expectation of regulation. No longer was the light touch, proportionate approach to regulation seen as creating a huge competitive advantage. Responsibly managed and well regulated financial services were considered to be vitally important to the economic welfare of society. As pictures of depositors queuing outside branches of Northern Rock were beamed around the World, society no longer wanted a system based solely on whether an institution conformed to specific legislative or regulatory rules or industry practice. We all came to learn about the importance of macro-prudential regulation and the need to ensure financial stability, a lesson which was reinforced a year later by the collapse of Lehman Brothers.
The banks understand that, this time around, the expectations of regulators, politicians and the public generally have changed dramatically since the start of the global financial crisis. Indeed, the signs are that many banks have heeded the lessons and are changing.
Safety in numbers
A fundamental question for the entire financial services industry is whether it is sufficient to comply with the letter of the law or should financial institutions look to act within the spirit as well? As the Salz Review of Barclays’ business practices observed, generally speaking, banks took too much comfort from the fact that some questionable practices were perceived to be standard in the industry. Those who challenged particular business practices were often met with the retort that “everyone does that". If being an outlier meant less profit or revenue for the client, only the bravest individuals had the confidence to challenge this stock response.
As yet another new era for financial regulation commences, the financial services industry finds itself again in a confusing transition. The expectations of society have without doubt changed significantly in recent years and this is inevitably reflected in the prevailing political mood. So, as the new regulatory authorities start to flex their muscles, we can hopefully look forward to a reformed regulatory system designed to limit the impact of institutional failure and minimise consumer detriment without destroying the spirit of innovation that the City so desperately needs in order to thrive.