The U.K.'s decision this week to scrap the Financial Services Authority (FSA) may signal that consolidated supervision doesn't work. But more likely it shows that the structure of bank regulation is beside the point.
The U.S. and U.K. could not have been more different in their approaches to supervisory structure, and yet both countries suffered immensely in the latest financial crisis. Canada, meanwhile, withstood the crisis remarkably well with a centralized regulatory model not unlike the one accused of failing the British.
"It would be nice if we had lots of studies done in different countries, all pointing in the direction of a single regulatory authority structure that works," said James Barth, a senior finance fellow at the Milken Institute who teaches at Auburn University. "But no such study exists."
What matters are the regulations themselves, and a country's willingness to enforce them. Whether those things are carried out by three agencies in three different buildings or by one agency with staff on three different floors makes no difference, Barth argued, so long as the rules are smart and the regulators are talking to one another.
Yet the debate over U.S. regulatory reform frequently has been dominated by turf issues and structural questions. Should the Office of Thrift Supervision disappear? Should the Federal Reserve's powers be expanded? How small must a holding company be for the Office of the Comptroller of the Currency to get supervisory authority over it?
Lost in the bickering is the unfortunate truth that a regulatory structure on its own is no defense against financial crises. And when executed poorly, it can hasten disaster, at least based on the British experience.
In announcing the breakup of the U.K.'s tripartite regime Wednesday, Chancellor of the Exchequer George Osborne said that "the very design of the policy framework meant that responding to an explosion in balance sheets, asset prices and macro imbalances was impossible." After the move to consolidate regulation in the late 1990s, he said, "The Bank of England (BoE) was mandated to focus on consumer price inflation to the exclusion of other things. The Treasury saw its financial policy division drift into a backwater. The FSA became a narrow regulator, almost entirely focused on rules-based regulation. No one was controlling levels of debt, and when the crunch came no one knew who was in charge."
The irony, of course, is that until the crisis, the U.K. model was upheld by many in the U.S. who favored a radical streamlining of regulatory agencies and a shift from an approach based on specific rules governing behavior to a principles-based approach steering firms toward the objectives of safety and soundness.
"We've gone in both directions in both countries, and we've proven in both cases with the last crisis that it's not structure that matters," said Robert Albertson, chief strategist at the investment bank Sandler O'Neill & Partners. This week's decision in the U.K., he said, "is the perfect example of the preference for structure over substance."
But some in the U.S. interpreted the announcement differently, framing it as a repudiation of a system lacking in proper checks and balances.
"To me it reaffirmed how much structure does matter," said John Ryan, executive vice president of the Conference of State Bank Supervisors. "The rules alone don't matter. You need a structure that has both accountability and perspective to enforce rules in a meaningful way. We need to recognize in developing our own structure that our political process, our society and our regulatory system as an extension of that can become subject to both pressures and euphoria, and that's where I think structure matters."
The U.K. and U.S. systems will resemble each other more than ever under the changes in the works on both sides of the pond. In the U.K., the job of regulating financial firms will return to the BOE, under a new subsidiary. In addition, the BoE will create a financial policy committee with duties akin to that of the systemic risk council proposed in the U.S. Also in the works is a consolidated bureau addressing economic crimes and, in another echo of proposed U.S. reforms, a separate authority overseeing consumer protection.
"What we are proposing is a new system of regulation that learns the lessons of the greatest banking crisis in our lifetime," said Osborne, whose country was stung early in the crisis by the collapse of Northern Rock and later by expensive bailouts for big institutions like Royal Bank of Scotland Group.
But it will take more than a transfer of responsibility to make the system more effective, said Michael Foote, chairman of Promontory Financial Group's U.K. office and a former BoE executive who helped design the FSA.
"I'm absolutely sure that if the BoE had been the banking regulator in 2007, they would not have picked up any quicker on the problems at Northern Rock," Foote said. He said it will be a "huge management and cultural task" to get micro- and macro-prudential regulators on the same page even if they are part of the same agency.