A History of UK Banking Regulation

Question 1

For the longest time, how was the Banking Sector regulated?

Answer 1

Through self-regulation.

Question 2

Which statute first formally regulated the Banking Sector?

Answer 2

The Banking Act of 1979, with the Bank of England as the formal regulator.

Question 3

Which landmark cases emblemized the formerly self-regulatory nature of the Sector?

Answer 3

United Dominions Trust Ltd. v Kirkwood [1966] 2 QB 431.

Question 4

What was Kirkwood’s significance?

Answer 4

The court based its determination of whether the defendant was indeed a ‘bank’ on the expert opinion of banking institutions in the City, thus emblemizing the sector’s self-regulatory character.

Question 5

Of yore, what was the Bank of England’s relationship to the Banking Sector?

Answer 5

One of informal oversight, as it was where bankers stored their gold reserves.

Question 6

During the self-regulatory era, did the Bank of England possess the LOLR Function?

Answer 6

Yes, as demonstrated by the Panic of 1866.

Question 7

Was the Bank of England’s LOLR Function universally extending in the days of yore?

Answer 7

No, only to those most-established banks in sector, creating an informal classification system of primary and secondary banks.

Question 8

What comprised the Secondary Banking Sector?

Answer 8

Small deposit-taking and credit-lending institutions.

Question 9

What ultimately spurred formal regulation in the Banking Sector?

Answer 9

1. The Secondary Banking Crisis in the mid-1970s.
2. The introduction of European banking legislation in 1977.

Question 10

Summarily, what did the Banking Act 1979 accomplish?

Answer 10

Regulation of those ‘non-recognized’ banks through the introduction of licensing, showing deference to recognized banks and leaving them be.

Question 11

What distinguishes a Recognized Bank from a Non-Recognized Bank?

Answer 11

Recognized banks were those deposit-taking and credit-lending instiutions which enjoyed, “a high reputation and standing in the financial community.”

Banking Act 1979 – Art. 1, Sch. 2.

Question 12

Which statute first formally regulated ‘Recognized’ Banks?

Answer 12

The Banking Act of 1987, as spurred by the failure of Johnson Matthey Bank in 1984.

Question 13

Summarily, what did the Banking Act 1987 accomplish?

Answer 13

1. Wholesale regulation of the Banking Sector.
2. Strict reporting standards, e.g. on loans >10% of capital.
3. Significant regulatory empowerment of the Bank of England.

Question 14

Following the 1987 Act, how could the Bank of England’s regulatory attitude be described?

Answer 14

Informal, with an emphasis on peer-to-peer discussion and ‘moral suasion’.

Question 15

What prompted the adoption of a more hard-line stance towards Banking Regulation?

Answer 15

1. BCCI’s failure in 1991 and the regulator’s contributory ineptitude.
2. Barrings Bank’s failure in 1995 and its reputational damage to the regulator.
3. The 1997 Labour Government’s agenda.

Question 16

When did the FSA replace the Bank of England as the Banking Sector’s singular regulator?

Answer 16

In 2000, due to the Financial Services and Markets Act 2000.

Question 17

What were the drivers behind the FSA’s usurpation?

Answer 17

1. Increased cross-sectoral activity and the need for complete financial regulation.
2. Informal regulation’s and self-regulation’s perceived impotence.

Question 18

What were the FSA’s Four Core Objectives?

Answer 18

1. Maintenance of confidence in the financial system.
2. Promotion of public financial literacy.
3. Consumer protection.
4. Combatting of financial crime.

Question 19

What Tactics did the FSA use to further its regulatory strategy?

Answer 19

1. The Functional Approach.
2. The Risk-based Approach.

Question 20

Describe the FSA’s Functional Approach towards financial regulation.

Answer 20

The FSA would require firms wanting to provide a particular financial service to obtain a corresponding license, so as to regulate firms on the basis of how they function.

Question 21

Describe the FSA’s Risk-based Approach.

Answer 21

The intensity with which a firm is regulated would correlate to the degree of systemic risk it posed, as per the probability and potential impact of its failure.

Question 22

What were the Fatal Shortcomings of the FSA’s regulatory strategy?

Answer 22

1. Neglect of low-probability systemic risks, e.g. Northern Rock.
2. Light-touch regulation.

Question 23

Which statute superseded the FSMA 2000 and introduced the Financial Conduct Authority and the Prudential Regulation Authortiy?

Answer 23

The Financial Services Act 2012.

Question 24

What are the core competencies of the FCA and PRA?

Answer 24

1. For the former, market health and conduct.
2. For the latter, financial firms’ solvency and robustness.

Question 25

What are the FCA’s core objectives?

Answer 25

1. Consumer protection.
2. Safeguarding financial markets.
3. Promoting competition.

Question 26

What is the PRA’s core objective?

Answer 26

To promote the safety and soundness of regulated firms, and consequently, the financial system, especially in cases of firm failure.

Question 27

What Tactics does the PRA use to further its regulatory strategy?

Answer 27

1. Risk-based supervision.
2. Judgement-based supervision.
3. Principles-based regulation.

Question 28

What is the PRA’s tactic of risk-based regulation?

Answer 28

It is the ranking and consequent regulation of firms according to the likelihood and severity of their failure on the financial system.

Question 29

What is the PRA’s tactic of judgement-based supervision?

Answer 29

The proactive regulation of firms with acute vulnerabilities as monitored by the regulator.

Question 30

What is the PRA’s tactic of principles-based regulation?

Answer 30

The practice of derivatively constructing its regulatory rulebook from a set of broad principles, trading off maximal robustness for flexibility.

Question 31

What is the Financial Ombudsman Service?

Answer 31

A mechanism for consumer redress against financial services providers for under £150,000.

Question 32

What is the current deposit protection scheme in the UK?

Answer 32

The Financial Services Compensation Scheme, which insures despositers for up to £85,000 per institution.

Question 33

How is it ensured that the FCA and PRA do not suffer from information asymmetries, as may arise from their differing purviews?

Answer 33

Through the introduction of manadatory cooperation mechansims, which obligates cooperation under specific circumstances.

Question 34

When do Mandatory Coordination Mechansims activate?

Answer 34

Proactively during both ex ante and ex post coincidences of regulatory interest.

Question 35

What are the PRA’s Powers?

Answer 35

1. Rule-making pursuant to objectives, e.g. the Rulebook.
2. Compulsion of relevant financial information from firms.
3. Investigation.
4. Enforcement.

Question 36

To whom is the PRA accountable?

Answer 36

Directly, to UK Government, and indirectly, to the Treasury and the Bank of England.

Question 37

What accountability mechansims is the PRA subject to?

Answer 37

1. Efficiency review, i.e. audits.
2. Independent inquiry.
3. Internal review in response to serious regulatory failures.

Question 38

Under what circumstances might an Independent Inquiry be issued?

Answer 38

Whenever an event arises that poses a high micro- or macro-prudential risk to the UK financial system, typically in relation to:

1. Collective investmnet schemes;
2. Listed companies;
3. Clearing houses; or
4. Interbank payment systems.

Question 39

How do the FCA and PRA manage relationships with stakeholders and the public?

Answer 39

Through the establishement of dedicated stakeholder panels and abiding by their statutory duty to properly consult them.

For more, see: R. v North & East Devon Health Authority ex parte Coughlan [2001] QB 213; Rusal (Jud Review) v LME [2014] EWCA Civ 1271.

Question 40

Who holds the FCA’s and PRA’s enforcement powers in check?

Answer 40

The Upper Tribunal for Finance.

Question 41

Are the FCA and PRA subject to Judicial Review?

Answer 41

Yes, but no case has yet succeeded against them.

Question 42

Are the FCA and PRA subject to civil liability?

Answer 42

Practically, no.

Question 43

Why is Goodhart concered about the separation of Banking regulation from the Central Bank?

Answer 43

Because while distinguishment might permit for more comprehensive regulation of the financial landscape, it might dually hinder the Central Bank’s ability to preempt and mitigate systemic risk.

C.A.E Goodhart – The Organizational Structure of Banking Supervision [vii-viii]

Question 44

Why does Goodhart believe it is important for the Central Bank to have a strong working relationship with an independent regulator?

Answer 44

Because in attempting to fulfill its macroprudential objectives, it will come to strongly depend on the independent, and vice versa.

C.A. Goodhart – The Organizational Structure of Banking Supervision [2-3]

Question 45

On principle, why ought Banking and Financial Regulation be divorced from the Central Bank?

Answer 45

1. ​The Bank’s macroprudential orientation doesn’t lend itself to microprudential regulation.
2. Dominion over both prudential dimensions would prove too much power for an independent undemocratic institution.
3. For a single regulator, regulating both prudential dimensions would present managerial, reputational, and effectual conflicts of interest.

C.A.E Goodhart – The Organizational Structure of Banking Supervision [8-23]

Question 46

On principle, why ought Banking and Financial Regulation be married to the Central Bank?

Answer 46

Because it provides the Bank with critical access to information that allows it to:

1. Better exercise its LOLR Function.
2. Better calibrate monetary policy, e.g. Transmission Mechanism.
3. Better safeguard the smooth operation of payment systems.
4. Maintain relations with the economy’s most important actors.

C.A.E Goodhart – The Organizational Structure of Banking Supervision [24-33]

Question 47

What is the Transmission Mechanism?

Answer 47

“The process by which asset prices and general economic conditions are affected as a result of monetary policy decisions.”

Wikipedia.

Question 48

Why might proper communication fail to bridge the informational asymmetries brought on by Regulatory Separation?

Answer 48

Information harvested by an independent may be biased towards its own objectives, thus proving suboptimally fit for Central Bank purposes.

C.A.E Goodhart – The Organizational Structure of Banking Supervision [8-29]

Question 49

According to Abrams and Taylor, what are the Prerequisites for Effective Regulation? (CODE-A-BBC)

Answer 49

1. Clear Objectives.
2. Operational Independence.
3. Democratic Accountability.
4. Effective enforcement powers.
5. Adequate funding.
6. Broad regulatory scope.
7. Bespoke infrastructure.
8. Cost-efficiency.

Abrams & Taylor – Issues in the Unification of Financial Sector Supervision [6-9]

Question 50

According to Abrams and Taylor, what are the Major Arguments favoring Regulatory Unification? (FACE-SG)

Answer 50

1. Increased Flexibility.
2. Increased Accountability.
3. Competitive neutrality.
4. Increased Efficiency.
5. Superior regulation of financial conglomerates.
6. Greater attractiveness to talent.

Abrams & Taylor – Issues in the Unification of Financial Sector Supervision [6-15]

Question 51

Why would Unification yield superior supervision of financial conglomerates? (GEEIC)

Answer 51

1. Greater ability to assess overall risk.
2. Elimination of information gaps and asymmetries.
3. Elimination of cooperative friction.
4. Increased regulatory and market efficiency
5. Consolidation of regulatory funding.

Abrams & Taylor – Issues in the Unification of Financial Sector Supervision [10-11]

Question 52

What is Competitive Neutrality?

Answer 52

The elimination of competitive pressure between regulators and supervisory arbitrage, chiefly through unification.

Abrams & Taylor – Issues in the Unification of Financial Sector Supervision [11-12]

Question 53

According to Abrams and Taylor, what are the Major Arguments disfavoring Regulatory Unification?

Answer 53

1. Mismanagement of conflicting regulatory objectives.
2. Diseconomies of scale due to uncompetitiveness.
3. Limited syngergies and economies of scope.
4. Moral hazard.

Abrams & Taylor – Issues in the Unification of Financial Sector Supervision [15-19]

Question 54

Why do the objectives of Microprudential Regulation and Consumer Protection conflict and lead to mismanagement under a single regulator?

Answer 54

Citing King, it is because they, “require different skills and a different approach.”

Ellís Ferran – The Break-up of the Financial Services Authority [463].

Question 55

What is the particular Moral Hazard being referenced in this context?

Answer 55

The alleged presumption that the public will take the treatement of the creditors of a given regulated firm as representative of how all creditors of all regulated firms ought to be treated.

Abrams & Taylor – Issues in the Unification of Financial Sector Supervision [18-19]

Question 56

What is the Financial Policy Committee?

Answer 56

A watchdog organization tasked with, “monitoring and addressing systemic or aggregate risks and vulnerabilities.”

Ellís Ferran – The Break-up of the Financial Services Authority [467].

Question 57

How does the Financial Policy Committee address systemic risks and vulnerabilities?

Answer 57

By, “giv[ing] directions to supervisors and to issu[ing] recommendations to supervisors, to the Bank and to the Government.”

Ellís Ferran – The Break-up of the Financial Services Authority [467].

Question 58

In the words of the Turner Review, why is the Adoption of a Systemic Approach essential?

Answer 58

Because it recognizes that different financial actors, i.e. banks, pose different levels of systemic risk than others, and thus require especially vigil regulatory diligence.

The Turner Review [52].

Question 59

Why do Banks pose comparatively higher levels of systemic risk?

Answer 59

1. Maturity transformation and its inherent fragility.
2. Contagion and bank runs.
3. Bank crises’ deeper and longer-lasting effects on the economy.

The Turner Review [52].

Question 60

How did the Turner Review propose to make Banks more resilient?

Answer 60

1. Increasing bank capital quantity and quality.
2. Increasing counter-cyclicality in regulation.
3. Implementing a gross leverage ratio backstop.
4. Decreasing the riskiness of trade book capital.
5. Decreasing procyclicality in regulation.
6. Offsetting procyclicality in published accounts.
7. Mitigating liquidity risk, e.g. through stress-testing and info reqs.

The Turner Review [53].

Question 61

Why is it necessary to focus on Economic Substance rather than Legal Form in International Regulation?

Answer 61

So as to neutralize the problem and consequences of inter-jurisidictional legal discrepancies.

Question 62

What is Macroprudential Analysis?

Answer 62

The practice of identifying systemically-problematic financial and economic trends and mitigating their resultant systemic risks.

The Turner Review [85].