FSA: Mindset change needed to avoid ‘no failure’ trap
Avoiding a no failure regime requires a change of mindset both inside the incoming Prudential Regulation Authority and in wider society, according to Andrew Bailey, managing director of the Prudential Business Unit at the Financial Services Authority.
In a speech in Edinburgh, Mr Bailey, who is also a member of the Financial Policy Committee at the Bank of England, highlighted that the PRA needs to establish a wide acceptance of its approach that orderly failure should not compromise its public policy objectives.
He said: “To be clear, we should be criticised where failure compromises those objectives and we could have taken steps to avoid it and we will be required to report on such failures.
“But if failure is orderly and does not compromise our public policy objectives, the responsibility should rest with the board and management for failing to serve the private interest of their shareholders and creditors.”
Mr Bailey also pointed out that having firms that are either too big or too important to fail is bad for competition.
He said: “An industry where exit is too difficult is one where entry is likewise inhibited. Put simply, if we don’t know how to deal with a failed firm, we will inevitably set a higher barrier to entry. This is what we see in the banking industry.”
Mr Bailey said at the present the FPC is pursuing two objectives: seeking to increase the resilience of the UK banking system, including to the threats emanating from the euro areas, and supporting the creation of credit in the UK economy.
Mr Bailey said: “I am in no doubt that if banks take reasonable steps to enhance their resilience, they will be better placed to sustain the availability of credit to the economy by lowering their cost of funding and reducing their vulnerability to unanticipated events.
“Macro-prudential regulation takes a system-wide view of the risks we face and the buffers of capital and liquidity that banks should hold against possible stress events. This is very clearly the resilience objective for the system, to which the FPC attaches great weight.”
Although he highlights that banks in the UK have made “substantial progress” over the last four years in building that resilience, Mr Bailey believes that there is further to go on capital.
He said: “We should also remember that more capital cannot be conjured from thin air, particularly as there are at present quite severe constraints around the rate of return earned by banks due to low interest margins and redress for past misdeeds on conduct issues.”