The chairman of the Financial Services Authority yesterday promised a "revolution" in banking regulation as he blamed the light-touch approach of his predecessors for letting banks go unchecked.
The FSA will vastly increase the amount of capital banks have to hold against risky trading strategies, and is prepared to ban risky mortgages and investment banking products, Lord Turner told MPs.
The overhaul of the watchdog's supervision of the financial sector would be "a revolution in approach," he told the Treasury Committee.
Lord Turner said the FSA's approach for regulating banks such as HBOS, which nearly collapsed last year, was wrong, and that the watchdog had been under political pressure to leave the banks to their own devices.
The FSA has been attacked by HBOS's former head of risk, Paul Moore, who accused the watchdog of failing to stop the bank pursuing a risky growth strategy and of approving his replacement even though she had no experience of overseeing risk.
"We were supervising people like HBOS within a particular philosophy of the way you do regulation, which I think in retrospect was wrong," Lord Turner said.
Hector Sants, the FSA's chief executive, admitted to the MPs that it was a mistake to judge senior bank appointments on a candidate's probity and not their competence for the job. "That is not a regulatory philosophy Lord Turner and I would agree with," he said.
"It was fairly overtly said that it was not the function of the regulator to cast questions over the overall business strategy of the institutions," he added. "You may find that surprising and in hindsight I find it surprising but that is the case. The overall political pressure was to say, 'Why are you looking at these matters? Can't you make it a bit more light touch?'"
Lord Turner's comments could be a further blow to Gordon Brown, who faces attacks blaming him for giving financial services free rein during the debt boom. The FSA chairman said the mood pervaded both political parties at the time.
The FSA has always rejected the accusation that it exercised a "light touch", insisting that its approach was "principles based".
Lord Turner took over as chairman of the FSA in September from Sir Callum McCarthy. Mr Sants replaced John Tiner as chief executive in July 2007, just as the financial crisis was emerging.
Lord Turner said that only with hindsight could he say that he would not have taken a similar approach to his predecessors and that the crisis had shown that regulators had to intervene because banks were unable to moderate their activities alone.
The FSA bosses differed over whether the FSA was fit for purpose now. Lord Turner said the regulator would be fit for purpose when all the changes had been made, whereas Mr Sants said it was already. George Mudie, a Labour committee member, pressed Lord Turner on whether the FSA was up to the job, saying: "I'm just a simple man asking a simple question."
Mr Sants then shifted his position to say that the "regulatory architecture" was not up to scratch and that the supervisory overhaul was two-thirds completed.
Lord Turner will publish his review of financial regulation next month.
He said banks would be made to hold "200 or 300 per cent" more capital against risky trading books and that this would deter them from becoming reckless. But he said the FSA may take direct action to bar products that are too complex for investors to judge the risk.
He also said the watchdog could act to outlaw racy mortgage multiples and that loans worth 85 or 90 per cent of a property's value could fall foul of a stricter line. He stressed that his report would not come to a conclusion on whether there should be intervention.
Lord Turner did not rule out the Government resorting to buying up banks' toxic assets and ringfencing them in a "bad bank".
The Treasury is expected to announce terms today for insuring banks against losses on loans and investments while leaving them on the lenders' balance sheets. "Nobody who has been in this crisis ... excludes anything," Lord Turner said.
He warned that as the economy worsened loans that seemed easy to value were becoming more dangerous and harder to put a value on, and that this was a "huge challenge" in working out how much capital protection banks needed.
Mr Sants defended the FSA's payment of bonuses to staff for 2008, saying staff had worked overnight and at weekends to deal with the crisis. He said there was a pool of £21m to hand out and that no employee would get more than 35 per cent in bonus.
Mr Sants said he held talks with RBS's chief executive, Stephen Hester, about the bank's recent pay deal for staff, which limited cash bonuses to investment bankers to a total of £175m and deferred the rest. Mr Sants said he had made sure that the bank's new pay structure "was consistent with our views".
Regulation: Report backs off on super-watchdog
A European taskforce has stopped short of calling for a pan-European regulator to oversee financial services but recommended the creation of a regional supervisor to monitor the biggest banks and insurers.
The taskforce, headed by Jacques de Larosiere, a former French central banker, has proposed a new European System of Financial Supervisors to provide co-ordination for regulators overseeing large institutions. But day-to-day supervision will be left with member states.
M. de Larosiere said that to have recommended a super regulator for the whole region could have been attacked for being unrealistic and could have proved expensive.
After crowing about the ability of its "principles-based" regulation to draw in business, the UK has feared a European backlash designed to weaken the City of London. The report's limited recommendations will bring a sigh of relief in Britain.
The taskforce also recommended a new European Systemic Risk Council to gather and analyse information on systemic risk and financial stability.
M. de Larosiere presented his recommendations to Jose Manuel Barroso, European Commission president, yesterday. The proposals will require a consensus among the European Union's 27 countries and will also have to compete with rival ideas put forward by the European Central Bank, which wants to take on supervision of the eurozone's biggest lenders.
Sean FarrellReuse content