Reforms could prompt major banking failure

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SENIOR OFFICIALS at the Financial Services Authority (FSA) are privately warning that a significant lowering of regulatory barriers to entry in the UK banking sector, as recommended in an interim Government commission report last week, could result in a major banking failure "within the next five years".

High ranking staff within the new City regulator's supervisory arm have serious reservations about the free market thrust of last week's report from Don Cruickshank, the chairman of the Government's banking review.

Regulators believe they are already getting the balance between depositor protection and competition right, and that to give the FSA a statutory obligation to promote competition would lead to confusion of purpose and a much greater likelihood of regulatory failure.

They also point out that the FSA and the Bank of England, from which the FSA took over prudential supervision, have licensed a significant number of new banks over recent years. These include not just established financial institutions like Standard Life and Scottish Widows, the mutual life insurance groups, but also supermarkets, Internet banking service providers, and foreign banks wishing to expand into the UK.

Gordon Brown, the Chancellor of the Exchequer, is understood to be willing to consider changing the thrust of the Financial Services and Markets Bill in the light of Mr Cruickshank's call for the regulatory system to be changed to allow banks to be exposed to more competition.

However, rather than following Mr Cruickshank's recommendations precisely, the Chancellor's initial preference is to find other ways of achieving the same goal.

Mr Brown is understood to have asked Treasury lawyers to spend the parliamentary recess studying ways in which the bill, which provides the legislative framework for the new Financial Services Authority, can be amended in order to meet Mr Cruickshank's concerns that regulation as it is currently applied to the banking sector is restricting consumer choice.

The Government has made it clear that while it shares the broad thrust of Mr Cruickshank's proposals for removing obstacles to greater competition, it is keen that both the banks and the FSA should be kept on board.

That may be easier said that done. Howard Davies, the FSA chairman, has reacted coolly to the Cruickshank proposals, commenting that any increase in the FSA's responsibility would require further staff resources. That suggestion has in turn received a dusty response from Treasury officials and the City, which through levies funds the FSA's work.

The headline proposal of the Cruickshank report that competition be included as a primary objective of the FSA has already been rejected twice by the Government, FSA officials say. It has also been considered and rejected by the joint parliamentary committee set up to study criticisms of the legislation.

Mr Cruickshank's undiplomatic approach has already antagonised the banks, who are concerned that the generally co-operative relationship that they have established with their new regulator could be undermined by the changes being proposed.

However, there is more sympathy from smaller niche banks, many of whom complain that their profitability and ability to compete is systematically undermined by the the regulator's insistence that they set aside more capital against potential defaults than the big banks like Barclays and Lloyds TSB.

The chief executive of one small private bank said: "Where Cruickshank has a point is that if you want to set up a new bank, the FSA will say you have to put aside 25 per cent of your capital against 4 per cent for Lloyds TSB. What the regulators hate the most is having to deal with lots of small financial institutions. In an ideal world, they would have just one big bank which could never go bust."