The City watchdog is to lose most of its powers to the Bank of England.
Each year, the Chancellor of the Exchequer delivers a speech on the state of the economy at Mansion House, the official residence of the Lord Mayor of the City of London.
Last night, coalition Chancellor George Osborne delivered this speech to the Lord Mayor and around 300 of the 'great and good' of the City.
Three years on, times are tough
Approaching the third anniversary of the start of the financial crisis, the Chancellor warned that "there is a well trodden path...from a banking crisis to a sovereign-debt crisis."
Thus, Osborne sees his single greatest economic challenge as dealing with "the highest budget deficit of any country in Europe, with the exception of Ireland." The Chancellor aims to trim the structural deficit through higher taxes and lower public spending, beginning in next Tuesday's emergency Budget.
The FSA's final countdown
Osborne also worried about the future of banking and financial services, regulatory uncertainty and the contraction of credit.
Indeed, Osborne argued that the current tripartite system of financial regulation -- with responsibilities divided between the Bank of England, Financial Services Authority (FSA) and HM Treasury -- has "failed spectacularly".
The Chancellor warned that the Bank of England has a mandate to tackle consumer price inflation, while the FSA is "a narrow regulator, almost entirely focussed on rules-based regulation." Thus, in order to prevent future bank collapses and public bailouts, he has decided to do away with a tripartite system that failed to tackle a "rapid and unsustainable increase in debt."
When it comes to valuing sound judgement over box-ticking in macro-prudential regulation, the Chancellor believes that only independent central banks are up to the job.
Hence, Osborne is to break up the FSA and hand over the bulk of its supervisory powers to a prudential regulator operating as a subsidiary of the Bank of England. This will regulate all financial firms, including banks, investment banks, building societies and insurance companies.
More new watchdogs
Giving yet more power to the Bank of England, the Chancellor will create an independent Financial Policy Committee to monitor -- and take action over -- macro issues which may threaten economic and financial stability. Mervyn King, Governor of the Bank, described this role as "turn[ing] down the music when the dancing gets a little too wild".
In addition, there will be a powerful new Consumer Protection and Markets Authority. This will regulate the conduct of every authorised financial firm providing services to consumers, ensuring good conduct, transparency and efficiency in retail and wholesale financial services.
Lastly, there will be a single agency to tackle serious economic crime -- a job that is currently dispersed among various government departments.
This regulatory overhaul will be completed by 2012.
Higher standards for financial firms
As part of this regulatory shake-up, the Chancellor accepts that banks will need higher capital and liquidity requirements in order to ride out economic downturns and bank runs (such as that seen by Northern Rock in September 2007). Also, excessive leverage and reckless lending need to be reined in -- something that the G20 group of nations will consider in their Seoul meeting in November.
Likewise, the Chancellor fretted about the size and structure of British banks. In order to tackle systemic risk, he will introduce a bank levy and demand further restraint on pay and bonuses.
Additionally, Osborne will create an independent commission on the banking industry. Chaired by Sir John Vickers, the commission will examine the structure of British banking and the competition (or lack of it) within, before reporting back to the government by September 2011.
Goodbye FSA, hello Hector
So, having been created by Gordon Brown in 1997, the FSA is to be broken up and scattered to the four winds. However, its current CEO, Hector Sants, has agreed not to resign but instead stay on for three more years, becoming the first new deputy governor and chief executive of the new prudential regulator.
Finally, I can imagine that this regulatory shake-up will lead to supervisory chaos through the City until 2012, particularly in compliance departments. However, this is a price well worth paying if the payoff is a more robust and transparent financial system for Britain.
What's your view on all these changes? Let us know in the comment section below...
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