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: Jim Hamilton's World of Securities Regulation

By Jim Hamilton

UK Conservative Party Would Abolish the FSA, Create Consumer Protection Agency, and Make Central Bank Systemic Risk Regulator

Noting that the Obama Administration has proposed legislation creating a new Consumer Financial Protection Agency to ensure that there is a regulator whose primary concern is protecting individuals, the UK Conservative Party said that when it reclaims power it will abolish the Financial Services Authority and create a new Consumer Protection Agency and give the regulation of financial institutions to the Bank of England. The policy white paper also said that the central bank would be deemed the systemic risk regulator for the entire financial system. These actions would effectively dismantle the current UK regulatory system that was created in 1997 with the establishment of the FSA as the unitary financial regulator.

In support of the plan, the white paper cites recent testimony of former Federal Reserve Board Governor Frederic Mishkin before the House Financial Services Committee. He said that the skills and mindset required to operate as a consumer protection regulator are fundamentally different from those required by a systemic regulator. Protecting consumers involve setting and then enforcing the appropriate rules under a transparent legal framework, reasoned the former Fed official, and the orientation of an effective systemic regulator must be different from that of a rule-enforcing consumer protection or conduct of business regulator.

The white paper envisions a central bank that would be responsible for macro-prudential regulation, judging and controlling risks to the financial system as a whole. This macro-prudential role will be carried out by a new Financial Policy Committee within the central bank, which would monitor systemic risks, operate macro-prudential regulatory tools and execute the special resolution regime for failing financial institutions.

At the same time, the central bank would also be responsible for the micro-prudential regulation of financial institutions, to be carried out by a new Financial Regulation Division. The policy report cited the practical advantages of combining the two responsibilities within the central bank, noting that central banks need a great deal of information about banks? balance sheets and behavior in relation to their monetary policy responsibilities and, at the same time, also need such information in relation to their responsibility for maintaining systemic financial stability.

Moreover, micro-prudential regulation can inform macro-prudential risk analysis. For example, if it is found that the exposure of many financial institutions to a particular sector has increased rapidly, this information can be picked up by the financial stability side of the central bank as a warning signal that a potential bubble may be building.

The new division for financial regulation should take a truly risk-focused approach to regulation, which the white paper described as a significant departure from the FSA?s historical approach. This risk-focused regulation would have a clear view of the areas and activities that create the greatest risk in individual financial institutions. For the largest and systemically important institutions this means that the central bank, as the systemic risk regulator, should have an awareness of the risk exposures by type. The central bank would also need to monitor conduct of business issues in so far as they have implications for an institution?s risk profile.

The new Consumer Protection Agency would have a mandate to examine pricing and product suitability as well as competition in financial services and products. Under the CPA, consumer protection would not simply mean following rules. Consumer regulation, like prudential regulation, would require regulatory judgments. While taking a tougher approach to enforcement and, where appropriate, product regulation, the CPA would also consider the consumer benefits of competition and low-priced products. For example, an expensive sales process which makes some products unaffordable may not ultimately be in the interest of consumers.

Full post as published by Jim Hamilton's World of Securities Regulation on July 22, 2009 (boomark / email).