Bank Regulation
♥ UK banks comprise many shares in the London Stock Exchange
♥ Banks suffer: share market suffers
♥ Impacts personal lives: we all rely on the banks
♥ Controversies about bank charges
♥ High charge for overdrafts
♥ Used customer lists to cross-sell financial products: pension scheme, mortgage, insurance etc.
♥ Banks in the UK have been profitable
♥ Causing financial problems to consumers
♥ Banks fund our economy: employers, makers of goods, providers of services, manufacturers etc. are funded in part by bank loans
♥ Can’t fund the ‘real’ economy if we make the bank operation difficult
♥ Banks are very powerful in our society
♥ There is an argument to curtail their activity (regulation): rules created by statute, enforced by governmental departments
♥ The law isn’t just being developed/enforced by individuals that have different interests: the area of regulation here is controlled by the government for the benefit of the general public
♥ Reasons to justify regulation:
o Paternalistic reasons: protect the vulnerable
o Social justice: achieve some measure of equality (different societies have different views)
o Protecting common goods: society has common features: clean air, payment system etc.
o Promoting efficient allocation of resources: insolvent banks are a large drain on resources: insolvency is ineffectively regulated
o Compensating for information asymmetry: giving key information to people giving their money to banks
♥ Banking regulation is new: goes back decades
♥ The legislature is trying to achieve:
o Accountability: huge powerful authority – who is it accountable to?
o Cost/benefit: regulation is needed, but it could be too expensive that it destroys the banking/financial service industry
o Transparency of process: in the UK we are good in transparency. Transparency is needed because the legislation is giving someone a lot of power. Everyone should know how the power is used.
o Fairness: everyone in the marketplace; new, old businesses
♥ Arguments against regulation:
o Unnecessary state intervention: the state is too big, we don’t need the state, free market regulates enough, weak businesses go into insolvency, strong businesses become more powerful
o Free market forces will shape the market and providers of services over time
o An over-protective state renders citizens helpless: we should take responsibility for ourselves, we decide what to do with our money, “nanny state”
o Regulation can never be perfect: don’t try! Didn’t solve banking crises before now
o Moral hazard: If a regulator or government takes responsibility for solving problems caused by incompetence, there will be no incentive for good behavior in the future “We’ll pay it for you”, e.g. RBS, Northern Rock
♥ Politics’ impact on regulation:
o Financial services sector in the USA is highly profitable money to spend on lobbying
o Lobbying is not necessarily a corrupt process: exchanging views and ideas, seeking to influence
o Freedom to pay large bonuses and salaries and dividends to bank shareholders
♥ UK regulatory control:
o Imposed by statute: Financial Services and Markets Act 2000
o Common law features less in this area (hasn’t kept up with the pace of change)
o New Financial Services Bill changes the identity of the regulator and its objectives: but this is not yet law
o In the UK, the regulator is the Financial Services Authority (s1 FSMA 2000)
o Conservative Party proposed that we abolish the FSMA in their 2010 manifesto
o Wanted to give regulation back to the Bank of England
♥ Bank of England:
o We have a central bank
o It has existed for a long time
o Almost every jurisdiction has a central bank
o Bank of England 1694
o It was founded as a company
o Subscribers to the memorandum (those who put money in) were the City of London merchants (got shares)
o Banker to the government and financed the war against France
o Inevitably makes them political?
o Lots of other bankers/goldsmiths who opened accounts with the Bank of England
o First loans were the first interbank loans to gain interest
o Bank of England settled the indebted nature between various banks
o Very strong influence on the banking system in the country
o Set interest rates on deposits made with it, others followed
o Supervisory role developed gradually
o Bank of England Act 1946:
♣ Gave the Bank of England the power to issue directions to other banks (what they can or can’t do regarding businesses abroad etc.) provided the government agreed (political)
♣ Gave the power to prevent mergers
♣ Settled the level of margin – what banks had to deposit as an insurance policy
♣ Nationalized the bank: owned by the government
♣ Aim to operate independently of the government (who is it accountable to?)
o Bank of England Acts 1979 and 1987:
♣ Duty to regulate and supervise all banks in the UK
o New labour government 1997:
♣ New super-regulator of all financial services in the UK: the FSA now regulates
o Many examples in history of central banks issuing money with profligacy – inflation – deutschmark 50 million worth less than $2
♥ Pre-1985: narrow markets, generally only provided one type of service each
♥ Made regulating much less contested, much easier
♥ Providers of FSs were regulated by their own industry organization (self-regulatory organizations)
♥ Insurance salesmen had to join organizations for regulating own membership
♥ Financial Services Act 1986: created one big regulator (weak, but existing)
o Securities and Investment Board:
♣ Controlled the self-regulatory organisations, which each focused on one sector
♣ The SROs wrote their own rule books and policed their own members
o Bank of England responsible for banking supervision
o It didn’t really work! It just created sectoral regulation
o Problems:
♣ Complicated rule books of SROs
♣ Lax supervision and enforcement
♣ New products (financial products like credit derivatives) and no rules to cover selling them
♣ System couldn’t deal effectively with conglomerates (different services grouped together)
♥ Scandals:
o Maxwell pensions:
♣ Robert Maxwell was a newspaper tycoon
♣ Powerful media enterprise
♣ Mirrorgroup Newspapers became insolvent
♣ Thousands of employees invested pension funds
♣ Pensions fund was severely insolvent
♣ Assets had been removed
♣ Pension fund regulator hadn’t been sufficient
o Barings Bank:
♣ Took disastrous positions in trading
♣ Bank became insolvent
♣ High profile example of UK bank forced into insolvency
♣ Directors’ fault but Bank of England hadn’t been effective in controlling behavior
o SROs hadn’t been effective
♥ New Super-Regulator!
o FSA created (SIB renamed)
o New raft of powers
o Extremely powerful
o Bank of England’s powers were removed: hadn’t prevented insolvency
o Successful model
o Powers were set out in FSMA 2000
o Copied in many parts of the world
o Objectives and duties
o Societal stability aims or individual customers’ fairness aims?
♥ Changes proposed by the Government in response to the banking crisis 2007-9
o Financial Services Bill
♣ Proposed more power in the Bank of England
♣ Responsibility for UK financial stability
♣ Macro and micro prudential regulation:
• (Solvency)
♣ Financial Conduct Authority to focus on markets and companies participating in them
♣ Don’t want the FSA supervising everything – government wants sectoral regulation!
Sectoral regulation (FSA 1986) was swept away by the Financial Services Act 2000
♥ Banks suffer: share market suffers
♥ Impacts personal lives: we all rely on the banks
♥ Controversies about bank charges
♥ High charge for overdrafts
♥ Used customer lists to cross-sell financial products: pension scheme, mortgage, insurance etc.
♥ Banks in the UK have been profitable
♥ Causing financial problems to consumers
♥ Banks fund our economy: employers, makers of goods, providers of services, manufacturers etc. are funded in part by bank loans
♥ Can’t fund the ‘real’ economy if we make the bank operation difficult
♥ Banks are very powerful in our society
♥ There is an argument to curtail their activity (regulation): rules created by statute, enforced by governmental departments
♥ The law isn’t just being developed/enforced by individuals that have different interests: the area of regulation here is controlled by the government for the benefit of the general public
♥ Reasons to justify regulation:
o Paternalistic reasons: protect the vulnerable
o Social justice: achieve some measure of equality (different societies have different views)
o Protecting common goods: society has common features: clean air, payment system etc.
o Promoting efficient allocation of resources: insolvent banks are a large drain on resources: insolvency is ineffectively regulated
o Compensating for information asymmetry: giving key information to people giving their money to banks
♥ Banking regulation is new: goes back decades
♥ The legislature is trying to achieve:
o Accountability: huge powerful authority – who is it accountable to?
o Cost/benefit: regulation is needed, but it could be too expensive that it destroys the banking/financial service industry
o Transparency of process: in the UK we are good in transparency. Transparency is needed because the legislation is giving someone a lot of power. Everyone should know how the power is used.
o Fairness: everyone in the marketplace; new, old businesses
♥ Arguments against regulation:
o Unnecessary state intervention: the state is too big, we don’t need the state, free market regulates enough, weak businesses go into insolvency, strong businesses become more powerful
o Free market forces will shape the market and providers of services over time
o An over-protective state renders citizens helpless: we should take responsibility for ourselves, we decide what to do with our money, “nanny state”
o Regulation can never be perfect: don’t try! Didn’t solve banking crises before now
o Moral hazard: If a regulator or government takes responsibility for solving problems caused by incompetence, there will be no incentive for good behavior in the future “We’ll pay it for you”, e.g. RBS, Northern Rock
♥ Politics’ impact on regulation:
o Financial services sector in the USA is highly profitable money to spend on lobbying
o Lobbying is not necessarily a corrupt process: exchanging views and ideas, seeking to influence
o Freedom to pay large bonuses and salaries and dividends to bank shareholders
♥ UK regulatory control:
o Imposed by statute: Financial Services and Markets Act 2000
o Common law features less in this area (hasn’t kept up with the pace of change)
o New Financial Services Bill changes the identity of the regulator and its objectives: but this is not yet law
o In the UK, the regulator is the Financial Services Authority (s1 FSMA 2000)
o Conservative Party proposed that we abolish the FSMA in their 2010 manifesto
o Wanted to give regulation back to the Bank of England
♥ Bank of England:
o We have a central bank
o It has existed for a long time
o Almost every jurisdiction has a central bank
o Bank of England 1694
o It was founded as a company
o Subscribers to the memorandum (those who put money in) were the City of London merchants (got shares)
o Banker to the government and financed the war against France
o Inevitably makes them political?
o Lots of other bankers/goldsmiths who opened accounts with the Bank of England
o First loans were the first interbank loans to gain interest
o Bank of England settled the indebted nature between various banks
o Very strong influence on the banking system in the country
o Set interest rates on deposits made with it, others followed
o Supervisory role developed gradually
o Bank of England Act 1946:
♣ Gave the Bank of England the power to issue directions to other banks (what they can or can’t do regarding businesses abroad etc.) provided the government agreed (political)
♣ Gave the power to prevent mergers
♣ Settled the level of margin – what banks had to deposit as an insurance policy
♣ Nationalized the bank: owned by the government
♣ Aim to operate independently of the government (who is it accountable to?)
o Bank of England Acts 1979 and 1987:
♣ Duty to regulate and supervise all banks in the UK
o New labour government 1997:
♣ New super-regulator of all financial services in the UK: the FSA now regulates
o Many examples in history of central banks issuing money with profligacy – inflation – deutschmark 50 million worth less than $2
♥ Pre-1985: narrow markets, generally only provided one type of service each
♥ Made regulating much less contested, much easier
♥ Providers of FSs were regulated by their own industry organization (self-regulatory organizations)
♥ Insurance salesmen had to join organizations for regulating own membership
♥ Financial Services Act 1986: created one big regulator (weak, but existing)
o Securities and Investment Board:
♣ Controlled the self-regulatory organisations, which each focused on one sector
♣ The SROs wrote their own rule books and policed their own members
o Bank of England responsible for banking supervision
o It didn’t really work! It just created sectoral regulation
o Problems:
♣ Complicated rule books of SROs
♣ Lax supervision and enforcement
♣ New products (financial products like credit derivatives) and no rules to cover selling them
♣ System couldn’t deal effectively with conglomerates (different services grouped together)
♥ Scandals:
o Maxwell pensions:
♣ Robert Maxwell was a newspaper tycoon
♣ Powerful media enterprise
♣ Mirrorgroup Newspapers became insolvent
♣ Thousands of employees invested pension funds
♣ Pensions fund was severely insolvent
♣ Assets had been removed
♣ Pension fund regulator hadn’t been sufficient
o Barings Bank:
♣ Took disastrous positions in trading
♣ Bank became insolvent
♣ High profile example of UK bank forced into insolvency
♣ Directors’ fault but Bank of England hadn’t been effective in controlling behavior
o SROs hadn’t been effective
♥ New Super-Regulator!
o FSA created (SIB renamed)
o New raft of powers
o Extremely powerful
o Bank of England’s powers were removed: hadn’t prevented insolvency
o Successful model
o Powers were set out in FSMA 2000
o Copied in many parts of the world
o Objectives and duties
o Societal stability aims or individual customers’ fairness aims?
♥ Changes proposed by the Government in response to the banking crisis 2007-9
o Financial Services Bill
♣ Proposed more power in the Bank of England
♣ Responsibility for UK financial stability
♣ Macro and micro prudential regulation:
• (Solvency)
♣ Financial Conduct Authority to focus on markets and companies participating in them
♣ Don’t want the FSA supervising everything – government wants sectoral regulation!
Sectoral regulation (FSA 1986) was swept away by the Financial Services Act 2000