SFA risk-rating system queried by Large

Sir Andrew Large, the chairman of the Securities and Investments Board, has questioned the new system of risk rating for investment banks and securities houses that the Securities and Futures Authority intends to introduce this summer.

Under the SFA's new regime, the 1,370 firms it regulates will be rated on a scale of one to five based on the level of risk involved in their operations and the quality of their management controls.

The new system will be used to determine how tightly firms are regulated, how often they are inspected and how much capital they must put up to cover the exposure in particular markets. Individual firms will be informed of their ratings this summer.

But in a speech to businessmen in Cardiff earlier this week, Sir Andrew, who as SIB chairman is in overall charge of regulating the financial services industry, pointed to some of the drawbacks of such a system and the dangers of misinterpretation.

Sir Andrew said: "If we make judgements about the riskiness in firms how will we find the right way to inform firms about how risky we think they are, when we have carried out our risk assessment? Feedback to the firm on the key points of the assessment is essential. But should this be done formally through some form of rating or risk profile? And if so, should the firm be told precisely what it is? And what about the public? Regulatory assessments can easily be misunderstood - one shudders to think of the systemic effect of a run on a bank as a result of an ambiguous regulatory assessment. We need to consider similar issues for non-bank firms."

SIB sources stressed it was strongly in favour of weighting the system of regulation so that firms perceived as being more risky were monitored more closely, visited more regularly and required to put up more capital.

But they were sceptical about using a formulaic rating system. "There are difficulties with categorising a firm from one to five because there is no single number that can encapsulate everything," one said.

The SIB is also thought to be concerned about firms using their SFA rating as a marketing tool to attract clients.

An SFA spokesman stressed that the purpose of the rating system was to enable it to decide internally how much attention it needed to pay to individual firms.

The SFA system rates firms in five categories - financial stability, quality of systems and internal control, business, supervisory complexity and quality of personnel and management. Although the SIB is responsible for supervising the work of the SFA, the Financial Services Act gives all the self-regulatory organisations in the City independence from one another and the SIB.

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