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Banking Law 3 Year Assignment...

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The United Kingdom’s banking supervision & regulation system is a system that has endured numerous transformations in the years since its inception.1 The purpose of this essay is to discuss banking supervision & regulation in the United Kingdom after the 2007-2009 crises, as well as evaluate if the reforms has been well, “effective”. Banking regulation refers to a set of rules and regulation that banks are expected to operate by.2 For example, capital requirements and ring-fencing. Banking supervision is simply the process of monitoring the financial performance and operations of banks, to ensure they are in compliance with banking regulation.3 The monitoring process is usually undertaken by regulators such as the Financial Conduct Authority.

There are two types of banking

supervision and regulation namely; prudential regulation which focuses on the solvency, safety & viability of financial institutions& 4 market conduct regulation which focuses on the methods used by financial institutions to deal with customers.5 It is important that both are in place adequately, to ensure an effective regulation & supervision system.6 The highly toxic impact of banking failure on an economic system is what has drummed up the need for effective regulation and supervision.7 As different financial crises have proved,8bank failures usually occur where there is no effective banking regulation& supervision in place.9 In 2012, a new regulatory architecture emerged, through the financial

1 Anu Arora, Banking Law(3rd Edn Pearson 2014) 123. 2 The Financial Services and Markets Act 2000. 3 Anu Arora, Banking Law(3rd Edn Pearson 2014) 123. 4 Anu Arora, Banking Law(3rd Edn Pearson 2014) 169. 5 Llewellyn, ‘The Economic Rationale for Financial Regulation’,(1999) Financial Services Authority Occasional Paper. 6 Anu Arora, Banking Law(3rd Edn Pearson 2014) 7 Ross Cranston and others, Principles of Banking Law (3rd edition Oxford 2018)76. 8 Llewellyn, ‘The Economic Rationale for Financial Regulation’,(1999) Financial Services Authority Occasional Paperhttp://www.fsa.gov.uk/pubs/occpapers/O01.pdf. accessed 07 January 2019. 9 Kaufman, Bank Failure, Systemic Risk and Bank Regulation, The Cato Journal, 16(1), http://www.cato.org/pubs/journal/cj16n1-2.html accessed 07 January 2019.

services act of 2012.10 This act marked the beginning of a twin peak system of regulation with the Bank of England at the centre.11 It consisted of two organisations associated with the bank of England; the prudential authority & the financial policy committee and the financial conduct authority.12 The move to the twin peaks system was to solve the major problem that the FSA, who was in charge during the crisis had, which was that it was practically impossible for a single organisation to handle banking regulation & supervision.13 Both types of regulation have different objectives, and those objectives can contradict each other.14Therefore, it is quite effective to have both systems of regulation handled by two bodies. SUPERVISORY ARCHITECTURE PRUDENTIAL AUTHORITY

The Prudential Authority is the first part of the twin peaks system and a part of the Bank of England.15 It is the body in charge of micro-prudential regulation in the United Kingdom. 16 Its primary objective is to promote and regulate certain firms that “manage significant balance sheet risk as a core of their business i.e investment firms, banks & insurers”. 17 It does this through policy making that militates against any possible failure outcomes and applying that policy through impactful supervision.18

10 The Financial Services Act 2012. 11 Anu Arora, Banking Law(3rd Edn Pearson 2014). 12 The Financial Services Act 2012. 13 HM Treasury, A New Approach, n 1, para 1.20. 14 MW Taylor, ‘The Road From “Twin Peaks” – And The Way Back’ (2009) 16 Connecticut Insurance Law Journal 61, 81-2. 15 Anu Arora, Banking Law (3rd Edn Pearson 2014.) 16 The Financial Services Act 2012. 17 Ross Cranston and others, Principles of Banking Law (3rd edition Oxford 2018). 18 Anu Arora, Banking Law (3rd Edn Pearson 2014).

Additionally, the PRA is particularly focused on systemic risk. 19 It employs regulatory policy to test’s a firms financial resilience & if it fails, it supervises it effectively. 20 This goes a lot further than what the FSA did, which was just “tick-boxing” in comparison. It also has a secondary objective, to facilitate effective competition.21 However, the PRA maintains that it will only do this, if it is reasonably in line with its primary objective. Nevertheless, where supervisory options would not yield benefits for the prudential regulatory side of things, but does for completion, the PRA is required to at least consider the completion benefitting option.22

Finally, the PRA’s supervision approach is also judgement led, forward looking & focuses on risk23. It is judgement led in the sense that, the intensity of a firm’s supervision is, will depend on how risky the firm is. It is important to note however, that there will be a minimum level of supervision across all firms.24 It is quite forward looking in that it examines firms against current risks and possible risks, and if necessary it will try early, to reduce the risks a firm is creating.25 Finally, its approach is key risks focused, as it focuses its supervision on issues & firms that are risky to the stability of the financial system26.

FINANCIAL CONDUCT AUTHORITY (FCA) On the other hand of the so called “twin peaks system”, is the Financial Conduct Authority (FCA).27 The FCA is an integrated conduct regulator that covers, retail, wholesale & market 19 Anu Arora, Banking Law (3rd Edn Pearson 2014). 20 The Financial Services Act 2012. 21 Financial Services and Markets Act 2000 Section 2H. 22 PRA, ’The Prudential Regulation Authority’s Approach to Banking Supervision’,(2016)

23 Ross Cranston and others, Principles of Banking Law (3rd edition Oxford 2018). 24 Anu Arora, Banking Law (3rd Edn Pearson 2014.) 25 Anu Arora, Banking Law (3rd Edn Pearson 2014.) 26 Anu Arora, Banking Law (3rd Edn Pearson 2014.) 27 Anu Arora, Banking Law (3rd Edn Pearson 2014.)

conduct.28 It has both a strategic objective & operational objectives.29 Its strategic objective is to protect consumers and promote confidence in financial markets. Its operational objectives include consumer protection objective, integrity objective & the competition objective. It also has a statutory duty to achieve its objectives in line with the principle of competition, as long as they are compatible with its strategic and operational objectives.30 In effect, it means that if the FCA in its pursuit of an operational objective, and it has two options to choose between with one being in conflict with competition and not, it must choose the one that does not hamper competition, if it is in line with its strategic objective. 31 This is further evidenced by the fact that, it also has a specific new power to require the office of fair trading to consider whether structural barriers are hampering competitive inefficiencies.

Additionally, it has specific principles of business contained in its handbook. 32 However, the FCA must also consider the principles of the Prudential Regulation Authority and Financial Policy Committee, when performing its duties.33 It must consider taking action that will reduce the possibility of a business to be used for financial crime.34

FINANCIAL POLICY COMMITTEE Sector 9 of the Bank of England act 1998(as amended by the financial services act 2012) 35 provides that the financial policy committee is situated within the Bank of England. Its main objective is to contribute to the Bank of England financial system stability objective. 36 It has

28 Financial Services Act Part 2, S6, 1b(2). 29 Financial Services Act Part 2, S6, 1c. 30 Financial Services Act Part 2, S6 31 Anu Arora, Banking Law (3rd Edn Pearson 2014.) 32 FCA ‘Handbook’, accessed 07 January 2019. 33 Anu Arora, Banking Law (3rd Edn Pearson 2014.) 34 Anu Arora, Banking Law (3rd Edn Pearson 2014.) 35 Financial Services Act, Schedule 1. 36 Financial Services Act, Schedule 3.

been entrusted with the duty of monitoring the financial system and identifies the risks to stability. In other words, it is essentially in charge of Macro-prudential policy decisions.37 It also sits at the top of the regulatory framework,38 as it is responsible for reducing risk in the financial system as a whole and can offer advice & directions to the bodies responsible for the oversight of the financial system.39 For example it can recommend changes to PRA policies on a “complain or comply” basis. The FPC also has financial stability duties, such as its Special resolution regime and crisis management duties.40 The crisis management memorandum of understanding details the responsibilities of Bank.41 The Treasury can advise the FPC in matters relating to what the FPC should “regard as relevant to the committee’s understanding of the Bank’s financial objectives” and matters which are important to the FPC’s functions.42 LEGISLATIVE REFORMS BANKING ACT 2009 The United Kingdom also enacted legislative reforms to deal with the financial crisis.43 These legislative reforms were essentially used to cement the regulatory architecture into place. The first of these was the emergency banking act of 2008. The act applied to any FSA regulated firm. The treasury could exercise its powers, where it found it reasonable for the purposes of, maintaining stability in the financial system & protecting public interest, where the treasury had provided financial assistance to the deposit taker.44 However, it was only 37 Anu Arora, Banking Law (3rd Edn Pearson 2014.) 38 Anu Arora, Banking Law (3rd Edn Pearson 2014.) 39 Anu Arora, Banking Law (3rd Edn Pearson 2014.) 40 Banking Act 2009. 41 Hm Treasury, A new Approach to Financial Regulation : the blueprint for financial reform (2011) 42 Anu Arora, Banking Law (3rd Edn Pearson 2014.) 43 Anu Arora, Banking Law (3rd Edn Pearson 2014.) 44 Banking Act 2008.

temporary. The banking act 2009 was more significant.45 It came as a result of a discussion paper & four consultation papers which looked into bank insolvency schemes. 46 The United Kingdom prior to the act did not have a specific scheme for bank insolvency. It used company insolvency rules, which are terrible for bank insolvency.47 This is because; banks are delicate organisations whose failures affect entire financial systems. Therefore, using company insolvency rules could actually worsen the situation as opposed to make it better. This is why it was not used in northern rock. The most significant thing about the act however is the special resolution regime (SRR) which was put in place.48 The SRR’S purpose is to provide stability when it comes to banking insolvency. It gave the FSA (now FCA), bank of England, the right to exercise special powers during a bank’s insolvency.49 It consists of three stabilisation options in the case of bank insolvency, which are, private sector transfer, bridge bank transfer and temporary public ownership.50 These applied to United Kingdom banks that could take deposits but it extended however to include a lot of financial institutions. Furthermore, FCA, Treasury & the Bank of England have certain powers when it comes to stabilisation with the SRR regime.51 The FCA determine, if the bank is in a position that would require stabilisation procedures, while the bank of England is in charge of actually executing the regime, unless temporary ownership occurs, in which case the treasury will do the honours.52 FINANCIAL SERVICES ACT 2012

45 Anu Arora, Banking Law (3rd Edn Pearson 2014.) 46 Anu Arora, Banking Law (3rd Edn Pearson 2014.) 47 Anu Arora, Banking Law (3rd Edn Pearson 2014.) 48 Financial Services Act 2012 section 1a. 49 Banking Act 2009, Part1. 50 Banking Act 2009. 51 Banking Act 2009, s7. 52 Banking Act 2009, S7(4).

The Financial Services Act 2012 essentially set the framework for the UK’s new regulatory architecture. The Act puts the Bank of England at the centre of macro-prudential responsibility for the financial system and prudential supervision.53 It provided for the establishment of the Financial Policy Committee (FPC), the Prudential Regulatory Authority (PRA) and the Financial Conduct Authority (FCA). It also makes extensive changes to the Financial Services and Markets Act 2000 (FSMA).

FINANCIAL SERVICES (BANKING REFORM) ACT 2013

The Financial Services (Banking Reform) Act 2013 (the Act) was enacted in December 2013, as a result of 12 months of deliberation. 54 The aim of the act is basically to lessen the likelihood and effects of a systemic financial crisis in the future.55 This is evidenced by the type of reforms it provides, some of these reforms include, “the introduction of retail ringfencing for banks; a preference for certain depositors on insolvency; a new bail-in tool; a new licensing regime; a new payment systems regulator; and a cap on the cost of payday loans”.56

The ring-fencing regime is an important part of the act. It implements an essential part of the recommendations of the Independent Commission on Banking (ICB) that UK banks,” should ring-fence their retail and small and medium-sized enterprise (SME) and deposit-taking businesses in legal entities which are separate to, and financially independent from, those entities undertaking riskier, wholesale and investment banking activities”.57 In other words, they are split into “legally separated ring-fenced and non-ring-fenced units”.58 The ringfencing is designed to improve bank resilience and resolvability, by protecting the retail part of the bank from the risk that could be posed from other parts in times of distress.59

53 Financial Services Act 2012. 54 Timothy, E. (2017). Banking Services Reform and Issues. (House of Commons Library 07234). House of Commons. 55 Ross Cranston and others, Principles of Banking Law (3rd edition Oxford 2018). 56 Financial Services(Banking Reform) Act 2013. 57 Timothy, E. (2017). Banking Services Reform and Issues. (House of Commons Library 07234). House of Commons. 58 Anu Arora, Banking Law (3rd Edn Pearson 2014.) 59 Anu Arora, Banking Law (3rd Edn Pearson 2014.)

Part VII of the Financial Services and Markets Act 2000 (FSMA), allows scope for transfer schemes which implement the ring-fence, and details how the regime is established in secondary legislation and PRA rules.60

THE BANK OF ENGLAND AND FINANCIAL SERVICES ACT 2016

Section 2A confirms “the Bank of England’s status at the centre of the UK’s economic and financial systems”.61 The Bank of England and Financial Services Act 2016 will mean the Bank of England is better equipped to fulfil its vital role of overseeing monetary policy and financial stability for the whole of the UK.62

In addition, it is the final piece of the bank of England’s phoenix like resurgence, in the UK banking sector reforms, which was a process began by the financial services act of 2012. The bank England prior to this has any abysmal record in terms of supervision and regulation.

The act provides for the improviement the governance and accountability of the Bank of England, through the subsidiary status of the Prudential Regulation Authority and allowing the National Audit Office to undertake value for money reviews of the Bank for the first time.63It also adds further measures to “protect tax payers from firm failure, by updating resolution planning and crisis management arrangements between the Bank and Treasury.”64

Also, the act also adds other provisions to improve consume protection, such as providing treasury with new powers to battle against anti-money laundry, as well as providing new measures to promote diversity and competition in the banking sector.65 It does this through

60 Financial Services and Markets Act 2000. 61 The Bank of England and Financial Services Act 2016, Section 2a. 62 Timothy, E. (2017). Banking Services Reform and Issues. (House of Commons Library 07234). House of Commons. 63 The Bank of England and Financial Services Act 2016. 64 The Bank of England and Financial Services Act 2016. 65 The Bank of England and Financial Services Act 2016.

“ensuring that regulators take into account different business models as part of their competition objectives”.66

EFFECTIVENESS OF REFORMS

The post 2007-2009 crisis UK banking sector reforms are just another element in a longline of banking sector supervision & regulation reforms that have been enacted in the United Kingdom for decades. All those reforms have had to be enacted because the previous reforms were not effective enough. Therefore, the question must be asked, have these reforms been effective?

To begin with, it can be argued that they have been effective. One of the reasons is due to the fact that, the new reforms have ensured that there is separated focus on both prudential and market conduct regulations.67 The FCA and Bank of England (PRA) now divide market conduct regulation and prudential regulation between them. There is no overlap between both systems and ensuring both systems of regulation are adequately focused on, is important to having an effective supervision and regulation system.68 If the supervisory and regulatory structure caters more to one of them, then this, can lead to an ineffective supervisory and regulatory system. This was proven during the financial crisis, where the Financial Services Authority (FSA) was entrusted with both prudential regulation & market conduct regulation, but it focused more on market conduct.69 According to a March 2001 ECB paper, the FSA was using 70 per cent of staff working time to focus on market conduct issues. This was ultimately fatal, because while it was concentrated on market conduct issues, it failed to consider the safety and viability of financial firms, and this was exposed when it endorsed northern rock as financially healthy organisation, when in truth it was not. 66 The Bank of England and Financial Services Act 2016. 67 Anu Arora, Banking Law (3rd Edn Pearson 2014.) 68 HM Treasury, A New Approach, n 1, para 1.20. 69 Turner Review, n 13, para 2.7.

In addition, another reason why the reforms can be said to have been effective, is due to the introduction of the special resolution regime scheme for bank insolvency via the banking act 2009.70 Prior to this, the only insolvency laws that existed were company insolvency laws. 71 The problem with these laws was that the procedures contained in them, put the interests of creditors and shareholders at the top of their welfare concerns, as opposed to consumer interests. This would be problematic in the context of failing banks; because creditor & shareholder interests will most likely collide with consumer (depositor) interests. If creditor and shareholder interests are put in front of consumer interests in failing banks, considering the inter dependent nature of banks, this can lead to financial system instability, as consumers will lose confidence in the system.72 Therefore, it is important that the procedures used to handle bank insolvency have consumer interests at the heart of it. The Special resolution regime actively caters to this need, as it gives the regulatory authorities the power to override shareholder interests &implement resolution measures that promote financial stability. 73

However, despite these, it can still be argued that the reforms can be said to ineffective. One of the reasons for this, is the fact that the bank of England has been put right back at the centre of regulation. The problem with this is that the bank of England actually has a terrible history with bank supervision and regulation, which questions its expertise. In the 1950s, the bank of England was the supervisory boss of a very flexible supervision & regulation system.74 It was a system that was based on the comprehensive difference between deposittaking institutions that were recognised as banks and those which were not.75 The bank of

70 Banking Act ...