Where next for banking regulations?

Heavier regulation of the financial services sector is not the answer to the credit crisis, according to the chairman of the Public Accounts Committee.

Edward Leigh, who leads the committee on the Government's ability to deliver and implement its ideas, says that company boards, macro-economic policy and the day-to-day running of the Financial Services Authority have as much a role to play as the style of regulation in maintaining the health of the sector.

"The key to a better regulatory system in the future is to make boards better understand the risks they are taking with our money - both current risks and new ones as they emerge. Bigger sticks for regulators will be of value only if they hit the right things with them.

"And what constrains Boards are not just the detailed rules and styles of regulation, but also macroeconomic policy," he argues.

Leigh refutes the suggestion that the current turmoil is simply a product of this so-called 'light touch regulation' implemented in the UK.

"Ending light touch regulation has become one of the cliches of the moment," he says. "[But] the crisis has been a global phenomenon. Banks across the world have struggled with liquidity, solvency and capitalisation, regardless of the type of regulation. So it doesn't really make sense to pin the blame on a particularly UK mode of 'light touch regulation'."

The adminstration of the FSA's regulations came in at £600 million in 2005 with the highest costs imposed by anti-money laundering regulations and regular reporting rules. 

"Trade bodies such as the British Bankers Association and the Association of British Insurers complained regularly about the intrusiveness of the FSA's approach. And the FSA certainly didn't think it was light touch either," he counters.

However, Leigh is sceptical of the FSA's calls for more money to implement its risk-based model of regulation better in the wake of the carnage in the financial markets.

"Perhaps the FSA first needs to focus on its operations. The FSA's own internal review of how it regulated Northern Rock revealed its management failings. Weirdly enough there was no requirement to present developed financial analysis to its own risk assessment panel," he says.

Under the Financial Services and Markets Act, the FSA falls outside of the remit of the Public Accounts Committee (the BBC is the only other public body not to come under the Committee's scrutiny). Unlike almost all regulators, it is not subject to regular audit by the National Audit Office.  

But banks also have bear some of the responsibility with their boards largely ignorant of the nature of the risks they faced, Leigh believes. "Firms had to increase their profits in line with competitors - otherwise, they would be less attractive to the market and engender hostility to the Board from their own shareholders. Qualms were ignored in the headlong rush towards exponential growth," he continues.

Interest rates have also played a part in the drama. He says: "I think history will conclude that base rates have been too low for too long, possibly because central banks ignored inflation in asset prices such as houses and shares. In the face of very low interest rates, perhaps no form of micro regulation could have prevented the massive expansion of credit."