The financial watchdog has proposed “major changes” in the way banks are regulated to help prevent a repeat of the crisis that brought many financial institutions to their knees.
In his long awaited review, Lord Adair Turner, chairman of the Financial Services Authority, recommends curbing the risk appetites of banks following the lending boom of recent years and the drive to maximise profits.
Banks will now need more 'good quality' money in their coffers than before to support “risky trading activity” with reserves built up during times of prosperity to cope with future downturns. Turner suggests they hold more cash and liquid investments in case the money markets (which many are reliant on for funding) dry up again.
Although this would hit profits, it would also help banks to stay on track when problems arise. With many banks now heavily paying the price for the boom years, Turner says the crisis has challenged previous belief in the theory of "rational and self-correcting markets".
One recommendation is potentially capping mortgage lending, to ensure borrowers have equity in their homes. This could see 100% mortgage - where people borrow the full value of their property - banned. However, Turner notes that restricting mortgage lending could damage the housing market.
He also suggests a new pan-European regulator be established to oversee the European financial sector, with current measures deemed “unsafe and untenable”. It would set the standards for other regulators to follow.
Turner says: “The approach has to build on a system-wide perspective: failure to look at the big picture was far more important to the origins of the crisis than any specific failures in supervising individual firms.
"And it must reflect the reality of a global financial system without a global government; we need both far more intense international cooperation and greater use of national powers.
“The changes recommended are profound, and the banking system of the future will be different from that of the last decade. The world’s economy will be better served as a result.”
Meanwhile, credit rating agencies, which have come in for heavy criticism during the crisis, also face regulation to avoid conflicts of interest and better gauge the risk of the assets they rate. And unregulated financial institutions, such as hedge funds, would be subject to stricter reporting requirements.
Despite the proposals for tighter regulation, Turner admits that the recommendations put forward in the review would not have prevented the collapse of Northern Rock or stopped Sir Fred Goodwin’s £16.9 million pension pot.
* Peter Vicary-Smith, chief executive of Which?, says: “Protecting consumers from rogue firms must be a priority if the FSA wants to rebuild public confidence in the financial services industry. The FSA must show it has real teeth by hitting companies with bigger fines and naming and shaming offenders.
“In terms of credit availability, we have gone from feast to famine. We welcome proposals designed to avoid a repeat of the current crisis but it is important that credit remains accessible to creditworthy individuals.
“If mortgages are to be capped, we must ensure that any restrictions don’t shut consumers out of the market so that they can’t re-mortgage and are stuck with their current provider.”
* Brian Morris, head of savings policy at the Building Societies Association, says: “It is appropriate that the FSA should be focussing on liquidity and capital requirements and we urge the FSA to concentrate its efforts on those areas of greatest systemic risk.
“We agree with Lord Turner that there were insufficient challenges to the assumptions of rational and self-correcting markets.
“On product regulation, it’s good to see that the FSA has identified the drawbacks of regulating mortgage products - restrictions through regulation could further stifle mortgage lending."
* Adam Phillips, acting chairman of the Financial Services Consumer Panel, says: “We are concerned that the Turner Review, for all its revealing content and excellent analysis, has not commented on the appalling way which banks have treated their customers both before and during the banking crisis.
"The review suggests that the FSA has been biased towards conduct of business rather than prudential regulation of banks. However recent history in terms of bank charges, the selling of payment protection insurance and mortgages shows that the FSA cannot be allowed to think it has the regulation of the consumer facing side of financial services under control."