2.3.2 Regulatory changes since 2000

Chris, what's the rationale for splitting financial services regulation between primarily two regulators the FCA and the PRA?

The origins of the split of regulation between the Prudential Regulation Authority and the Financial Conduct Authority go back to the financial crisis. Looking at the crisis and what happened during there around regulation, the government said that the then so-called tripartite model, in which the Treasury, the Bank of England and the then Financial Services Authority shared responsibility for regulation, had created a degree of confusion and a degree of inaction in the response to the crisis and so what was created subsequently was two bodies with very clear mandates, the Prudential Regulation Authority, which is now obviously sitting as part of the Bank of England with a very clear focus on the very largest prudential risks and then the Financial Conduct Authority, picking up the remainder of the prudential risks that might exist in the market but also a very clear focus on conduct. And by having those two bodies with very clear mandates plus the Financial Policy Committee sitting over the top to bring co-ordination to that the sense was we would have a better, stronger system.

What do you think are the biggest challenges for the regulators in the wake of the financial crisis and the catalogue of mis-selling episodes over the course of the last few decades?

There are a couple of really big challenges I think we have at the moment. So the first is the crisis itself spawned an enormous amount of regulation at both European level but also domestically, some of which is still flowing through so it actually hasn't taken effect at this moment in time. It's still in the final stages of being put together particularly at European level. One of the things I think we have to be able to do is to say that was a response to a very difficult moment in time. Undoubtedly every decision that was made at that moment in time won't prove to be right so how do we make sure that we've got a sustainable model of regulation? The danger is that you know we regulate for crises we back away completely when those crises seem to be receding. Actually, how do you get something in the middle which is long term sustainable? The second piece I think for us particularly coming out of that package of reforms, is how do we ensure we have real responsibility laid at the door of senior managers who are running firms and that we can have very clear accountability for the good conduct of businesses.

I'm curious about what's happened to the supervision of banks over the last few years. After 1997 the Bank of England lost its responsibility for supervising banks. It went, in due course, to the FSA. Now, following recent reforms to regulation, the PRA, which is a subsidiary of the Bank of England, has now got responsibility for supervising the large banks for large deposit takers, the large insurers and investment banks. It's come back to the Bank. Not all of it admittedly. A lot of firms are still regulated by another organisation, the Financial Conduct Authority.

But why this sort of movement in terms of supervision? You lose supervision of the banks and now you get it back. What's going on?

So you're right. There has been a moving around in the regulatory architecture, first one way and then the other over the course of the last twenty years or so. And when you think back you know more than twenty years you know back then the Bank of England had responsibility for the supervision of banks, not insurance companies, but just banks.

In '97 we were granted independence for monetary policy and at that time there were some concerns that there could be some, if you like, reputational contagion between the banking supervisory part of the bank and the monetary policy part, in particular if banks were to fail that might cause some reputational damage for the bank in a way that could then leak across and affect the monetary policy side. That was one of the rationales for moving supervision out of the bank and into a separate regulatory agency, the Financial Services Authority. There were other rationales including the fact that the FSA became a unified regulator of not just banks but of insurance companies and investment funds as well.

So why the move back a couple of years ago? Well, the crisis taught us a lot and two of the most important things it taught us were that reputational contagion can happen even if you haven't got responsibility for banking supervision and that's what we at the Bank found. But secondly - and in some ways most importantly - more importantly the crisis taught us about the close inter linkage between the financial system and the economy. It was failures in the financial system that brought the economy to its knees and if we are to avoid failures in both we need to exchange information on both. And in some ways the new regulatory architecture recognises that by placing responsibility for both financial systems stability and for stability of the wider economy under a single roof at the Bank of England

Okay. So you're sure then? There's no sort of potential compromise here in terms of the Bank's position, conflict of interest? On the one hand you're looking after monetary policy and monetary policy obviously affects banks, and on the other hand you're looking after the banks in terms of supervision. Isn't there just a little bit of a hint of conflict of interest there?

I mean I think in some ways quite the opposite, in fact. You think back through history, and including recent history where the biggest contribution that could have been made on the regulatory side, was to try and head off that collapse we saw in the economy in '08/'09. There was a situation where you really would want to have had the monetary policy functions and the regulatory functions working hand in hand. In other words if regulation had been somewhat more somewhat tighter that would have reined back, somewhat, the credit bubble we saw and therefore the collateral damage to the economy would have been somewhat less. And, similarly, at the moment we have a situation where interest rates are very low. It's generating some pressures in some financial markets and rather than having to raise interest rates which would damage the economy, we can use regulation to try and keep some of that bubbly behaviour under control. So actually far from being at conflict I think these two things are very natural complements.

I just want to go back briefly to the financial crisis, the mayhem which it produced, and reflect a bit. I mean looking back at regulatory failures which were revealed by the crisis I mean what do you think were the causes of those failures?

Well I think in some ways the deep causes weren't just on regulatory failure.

Right -

For me this is really at root an intellectual failure, an analytical failure, an ideological failure not just on the part of regulators but on the part of central banks, on the part of academics, on the part of financial market participants, all of whom, each of whom, held too much faith in the ability of financial markets to do the right thing and to self-correct and therefore all of us, collectively, individually, were somewhat guilty of giving them rather too free rein in the run up to the crisis and allowing that build-up of debt and of credit to go too far in ways that spilt back and hurt us all. So rather than, I think, laying the blame at any particular regulator, or indeed even at regulators collectively, we can afford to share the blame around pretty liberally because actually if truth be told each of us in our own way were getting this a bit wrong.

Okay. So we're all a little bit guilty then basically by the sound of it that's true?

But with the benefit of hindsight do you think it was a mistake to have a unitary regulator, to have all regulation placed within one body? Surely there is just too much to do and you know the management of a huge array of financial firms of varying sizes and all the issues which they generate in terms of regulatory need and, in terms of supervision, surely that's just too much for one organisation?

So I'm of the view really that there is no perfect regulatory structure out there. If there were we would have long since discovered it either in this country or internationally and you look round the world right now and there are a whole pattern - a whole rich array of regulatory architectures. And I think saying this one is the model for the world and this one is not is fanciful actually.

Historical experience suggests that it is fanciful to think there is some Nirvana, some regulatory Nirvana out there. That said I do think there were features of the fully integrated model which with the benefit of you know 20/20 hindsight may not have played out as well as you would have hoped. Let me mention one in particular which is the bringing together under one roof of Prudential Regulation on the one hand and Conduct of Business - Consumer Protection - on the other, I think that is quite a stretch. I think these are quite different functions to be put under one roof. And in particular I think it was the case at the Financial Services Authority that the Act of Consumer Protection was so resource intensive and absorbing that that may have drawn energy and attention away from the Prudential side of the old FSA's responsibilities and that may have contributed, contributed no more than that, to sowing the seeds of the crisis that built up.

So let's look at regulation how it currently is and in due course we will see how successful this structure turns out. We look at this in the course and we know that the key institutions are the Financial Conduct Authority and the Prudential Regulation Authority, which are a subsidiary of the Bank of England. But also lurking in there you've got the Financial Policy Committee haven't you which may be less well known to the public but it's important. What does it do and how does it fit in with the rest of the jigsaw?

You're right. It is important. And it's the new part of this regulatory jigsaw that you mention and here's the way to think about it, the new architecture for policy if you like, which is that we have the Prudential Regulation Authority, the PRA, whose primary responsibility is for the supervision and regulation of individual financial firms, be they banks or insurance companies or investment funds and it's important of course that function is done well for reasons that were made clear - made clear during the crisis. What the FPC, the Financial Policy Committee, does is not so much look at individual financial firms but rather to look at the system as a whole, to look at broad trends in the financial system. Is credit growing too rapidly? Is leverage within the system building up at too fast a rate, a worrying rate, in a way that could cause damage not just to individual financial firms, banks, insurance companies, but could actually imperil the financial system as a whole, the like of which of course we saw in 2008 and 2009. So their role is to take action to try and keep the system as a whole on an even keel, using so called macro Prudential instruments, that is using Prudential tools, regulatory tools, but having them serve a macro, a system wide, end rather than an individual firm end.