Lord Turner, the Chairman of the FSA, in his March 2009 report entitled “A regulatory response to the global banking crisis” accepted that the supervisory authorities should shoulder some of the blame. He noted that there had been a failure to undertake macro-prudential analysis by the regulatory authorities. Macro-prudential analysis is the identification of “trends in the economy and in the financial system which have implications for financial stability and as a result for macroeconomic stability” and identification of “the measures which could be taken to address the resulting risks”.

He added that:

• the Bank of England had focussed on monetary policy and, while it had carried out some excellent analysis in its Financial Stability Review, had not come up with any policy responses to meet the risks identified
• the FSA had focussed too much on individual institutions and too little on “wider sectoral and system-wide risks”
• as a result macro-prudential analysis fell between two stools

The FSA approach according to Lord Turner, involved:

• a focus on individual institutions
• a focus on ensuring that systems and processes were correctly defined rather than on challenging business models and strategies
• a focus on ensuring approved persons were of the right character rather than on being technically competent
• a bias towards business regulation rather than prudential regulation

His conclusion was that “the combination of these features, underpinned by the then dominant philosophy of confidence in self correcting markets, meant that even in the many cases where the FSA did meet high standards in the execution of its regulatory and supervisory approach, it was not with hindsight aggressive enough in demanding adjustments to business models which even at level of the individual institution were excessively risky and which pursued simultaneously by several banks, contributed to the build-up of system-wide risks.”

In his report, Lord Turner noted that the FSA had already undergone a major overhaul in terms of its approach to supervision although there were still important changes to be made

A Government White Paper published in July 2009 acknowledged that a new approach was needed to tackling global systemic risks but that this would be undertaken using the current institutional framework with “the FSA responsible for conduct of business and prudential regulation for all financial services firms” and “the Bank of England responsible for financial stability”.

This framework would be “strengthened further through increased powers for the Bank and FSA, better co-ordination between them, and strengthened governance and greater transparency”.

Whether this will be the pattern for the future hinges on the result of the next general election due in 2010. While the present Government envisages a system based on the status quo, the Conservative Party envisage a shift of power back to the Bank of England.

What should be remembered is that the Bank of England’s regulatory record is not without blemish. The Bank was the regulatory authority when both BCCI and Barings hit problems. What neither party will want to see is the introduction of a regulatory system that kills the golden egg.

There is always a fine line between policing the financial system on the one hand and allowing innovation to continue on the other hand.

There is, however, a case for regulation to be more international in tone. Of all industries, the financial sector is probably the most global and also carries the most risk to the global economy if it breaks down.

It is difficult for any domestic regulatory authority to police large multinational banks and financial institutions. International co-operation is a must.