The House of Commons Treasury Select Committee has criticised banks for ignoring warnings about risky lending, and hit out at regulators for not making sure that lenders listened to their concerns.
In its second report into the causes and lessons of the market turmoil, the committee said the system for regulator warnings was "deficient" and demanded it be strengthened to ensure that banks give proper consideration to regulators' warnings.
In evidence to the committee, the Governor of the Bank of England, Mervyn King, along with the chiefs of the Financial Services Authority, said they had given banks repeated warnings in speeches and reports in the first half of last year. The regulators had cautioned that banks were lending too freely and were over-dependent on abundant liquidity, using new credit products to unload risk.
Mr King blamed "hubris" within financial institutions for their lack of action, but the committee said it was not enough for the regulators to make speeches and hope someone would listen.
The MPs said the regulators should send a short letter to institutions highlighting major concerns to be discussed at board level. The Bank and the FSA should also require confirmation that the risks had been discussed and publish commentaries on the responses, the committee said.
John McFall, the chairman of the committee, said: "Many market participants failed to heed warnings about a serious under-pricing of risk ... The Bank and FSA can no longer hedge their bets, throwing potential risks out into the ether and then washing their hands of the consequences."
In recent weeks, Britain's banks have reported billions of pounds in writedowns from the unwinding of the credit boom, either from investments in complex treasury products or losses on loans left on their books. The writedowns have been lower than were feared, but concerns remain about further charges and damage to the wider economy.
The report said the parcelling up of debt by banks had brought some benefits to the system by allowing risk to be dispersed, but it said banks had taken the model too far. Investors were also attacked for buying into products they did not understand in a quest for easy returns.
Mr McFall said: "The 'best and the brightest' at our top investment banks have expended great energy designing ludicrously complex financial products, which you need a Nobel Prize in physics to understand ... Many investors were blind to the risks involved, equated complexity with security and were engaged in a bout of collective madness."
Investors relied too heavily on ratings by agencies such as Moody's and Standard & Poor's, which gave top-notch AAA rankings to products that contained risky assets, the committee said. To avoid new regulation, the agencies need to reform their practices to eliminate perceived conflicts of interest in the way they work with banks to structure products, the MPs added.
The committee said it did not support prescriptive regulation, saying investors should bear the consequences for their decisions. But the rating agencies must give more information to investors along with their ratings.
The MPs expressed concern about a "triopoly" of Moody's, S&P and Fitch dominating the ratings market. The committee called on competition authorities to examine barriers for entry into the market.
The committee's Financial Stability and Transparency report follows its earlier investigation into the near-collapse of Northern Rock as markets seized up. That report sharply criticised the FSA and the Bank of England for their handling of the crisis. Last week, Hector Sants, chief executive of the FSA, made his starkest admission yet that the watchdog had been at fault over Northern Rock.
Mr McFall said: "We will be examining whether the Bank of England and the FSA have raised their game and are sharpening their analysis of key risks in the financial system."
The committee will also look at the role of sovereign wealth funds and payment incentives at individual banks in its further work on financial stability.Reuse content