FSA chief: financial crisis is entering 'third act'

The head of the City watchdog yesterday warned financial institutions that their business models might not withstand tougher conditions as the global market turmoil plays out.

Hector Sants, chief executive of the Financial Services Authority, told the regulator's annual meeting that the crisis, which moved from a liquidity freeze to concerns about capital, is entering a "third act" featuring a downturn in the wider economy. Companies must realise that the final act will see no return to the recent era of easy money.

"The good news is that we are moving through the acts. But the risks in each are material and neither we nor our firms can afford to relax," Mr Sants said. "The new normal will require firms to adapt their business models, consumers their spending patterns and consequently generate new challenges and change for us."

After Northern Rock nearly collapsed, the Government is drawing up new rules to deal with a failing bank which have exposed differences between the FSA and the Bank of England. Mr Sants and Sir Callum McCarthy, the FSA chairman, gave limited approval to the call by Mervyn King, the Bank's governor, for a new deposit protection scheme to be pre-funded by banks. They said that though Mr King's argument – that it would help deter recklessness – was sound, the scheme had to be affordable and show it was possible to charge banks according to their their risk level.

Mr Sants said that getting supervision up to scratch would drive the FSA's costs above the estimate in its business plan for the year. The FSA will try to make savings to avoid charging companies more but they could face extra bills next year, he added.

Mr Sants also indicated that the FSA's decision to force disclosure of significant short positions in companies doing rights issues had prompted some short investors to close their positions to avoid disclosure. The FSA brought in the rule because it suspected market abuse by shorters driving down bank share prices during rights issues.