Tripartite move to strengthen bank regulation

Moves to learn the lessons of the humiliating run on Northern Rock last autumn were announced by the "tripartite authorities" yesterday. Aiming to produce a "world-class" regulatory system, the Bank of England, the Treasury and the Financial Services Authority jointly agreed on a range of moves aimed at strengthening each and improving liaison.

Many commentators, including the Treasury Select Committee, drew attention to the apparent lack of leadership during the Northern Rock crisis and the credit crunch.

Soon, a "Tripartite Standing Committee" of the Bank, the Treasury and the FSA will be formed to ensure the bodies work together.

A consultative document, "Financial stability and depositor protection", laid out new powers for the Bank of England to administer a distressed bank under a "special resolution regime", the right to request information, via the FSA, on such banks and for any emergency provision of funding to financial institutions to be made secretly. Many believe had the new rules and provisions been in place last year, the Northern Rock crisis would have been less likely to spin out of control. It follows a consultation document published in January. After further discussions, legislation is expected to come into force by next February.

The Bank of England will be given a statutory responsibility for "financial stability" as a "high-level objective", though there will be no definition of this in the legislation. The Chancellor of the Exchequer will inform the Governor of the Bank by letter what he would like him to focus on, as he does with monetary stability and the inflation target.

Whether the Governor will have to write a note of explanation at times of instability, as with excessive inflation, is unclear. The Governor and his colleagues will also be overseen by a new Financial Stability Committee, a sub-committee of the bank's governing body, the Court, which will be slimmed down and "modernised". Some MPs have called for "market professionals" to be on the Court and the FSC, although the potential for conflict of interest would have to be addressed.

The responsibility for pushing a failing bank into the Special Resolution Regime will rest solely with the FSA, as the Chancellor made clear in his Mansion House speech. There had been some discussion as to whether the Bank of England might have an early role in this process.

The FSA will enjoy improved powers to supervise banks and will look more closely at the liquidity position of institutions, a key failing in the Northern Rock affair. International moves via the Basel Committee, the Financial Stability Forum, the IMF and the G7/G8 were also announced, with the aim of issuing "early warnings" of financial problems, strengthening the regulation and transparency of off-balance sheet and complex financial instruments and augmenting international co-operation. New provisions, agreed with the Ministry of Justice, to provide "whistle-blowers" with immunity for providing the FSA with details of market abuse are also proposed.

The limit for the Financial Services Compensation Scheme, or deposit protection, will rise from £35,000 to £50,000. The consultation says: "The authorities remain committed to a target of seven days for providing the depositors of a failed bank with access to at least a proportion of their funds, and the balance within the following few days, consistent with the aim of minimising disruption for depositors."

The Governor of the Bank, Mervyn King, and his colleagues seem to have fought a successful rearguard action against the Treasury and have won a provision in the new legislation that could eventually make the deposit protection scheme "pre-funded".

In a speech to the British Bankers' Association on 10 June, Mr King argued that "some element of pre-funding is one of those ideas that is bound to be unpopular before the fund is called upon, but seems decidedly wise after the event as it lessens the burden on the banking system in a time of stress".

Although the arrangements when they come into law will not be "pre-funded", there will be provision for that to be brought into force, which could be when the credit crunch eventually eases. For the moment, the scheme will be funded by borrowing from the Government, which will charge interest and be repaid from the proceeds of any break-up or dissolution of a bank and, if necessary, by a levy of all the banks under the compensation scheme.

The British Bankers' Association said: "We have been talking with the Government and regulators about intervening earlier should a bank get into difficulties to prevent a banking problem becoming a crisis. The UK has a strong and robust banking system and a depositor protection scheme which already protects fully some 96 per cent of depositors."