Tuesday, 29 January 2008

False positives and false negatives

The Treasury select committee report on Northern rock has some criticism for a range of targets from Alistair Darling, through the board of the bank itself, to FSA. While none of it boils down to 'hang them from the nearest telegraph pole', FSA in particular comes in for considerable censure.

According to the FT:

Sweeping new powers to oversee financial stability and prevent a repetition of the Northern Rock crisis should be handed to the Bank of England, a parliamentary committee proposes on Saturday in a report that lambasts the Financial Services Authority for systemic failure in its duty as a regulator.

I don't know the details of what FSA did or didn't do, so I won't comment on the specifics. But a few general remarks about financial supervision might be appropriate.

  • Firstly it is utterly inappropriate for a regulator to comment on bank strategy. Yes the Rock had a strategy that turned out to be flawed, but provided the necessary statutory disclosures were made and the bank was capitally adequate, what could FSA do about it even if they understood the issue? Having regulators comment on strategy is tantamount to them writing a put to shareholders.
  • Regulators have to be careful about calling wolf, especially given the impact any public intervention would have on the market. The balance between intervening too early and too late is a very difficult one, especially for a public body that is necessarily bureaucratic (not least because its actions are susceptible to judicial review). Again I'm not suggesting that FSA didn't get it wrong in this case, just that to make an informed judgment we also need information from the thousands of cases where banks did not fail. The skeptic might suggest that thousands of banks a year don't get into trouble so doing nothing is usually safe, and I'd agree, but that just emphasises the difficulty of finding a true positive in a sea of negatives.
  • What on earth makes the Treasury select committee believe that the Bank of England would be any better at bank rescues than FSA? Surely one lesson from this debacle is that the tripartite system has one (or perhaps two) legs too many. Having a part of the Bank for FSA to hand over problem cases to will just exacerbate the communications overheads and inter-institutional conflict in the system.

Few would suggest FSA is the perfect regulator. But having a single body responsible for banks, investment firms, insurance companies, and financial intermediaries is a good start. Fewer regulators not more would make a good motto, as the BIS recently pointed out. Why not make a merged Bank of England/FSA truly responsible for the whole thing from soup to nuts, including authorisation, regulation, deposit protection, rescues, rate setting and the operation of the discount window? Then nothing can fall between the cracks between institutions and if something goes wrong we will really know who to blame. That might be too controversial a suggestion for the Treasury select committee, but it would be better than yet another regulatory kludge.

Update. It seems Alistair Darling agrees. He rejected the committee's advice, saying that plans put forward by a committee of MPs were flawed and would not deflect him from his own reforms of Britain's system of financial regulation.

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