Financial regulation in the UK is ripe for a serious rethink

The writer is a former chair of Lloyds Banking Group and a member of the House of Lords industry and regulators committee

With the latest financial services and markets bill starting its passage through the House of Lords, the doomsayers will be lining up to claim that these post-Brexit reforms to the UK financial markets will weaken regulatory safeguards, risking a repeat of the 2008 financial crisis. In reality, however, much bolder reforms are needed to clear away the unproductive regulatory overhead that has accumulated over the past decade and allow the UK’s global financial services sector to flourish.

Of course, many of the regulatory innovations that followed the financial crisis remain relevant and sensible. The regular stress testing of capital and liquidity against a variety of shock scenarios is a vital part of the regulatory framework. And given increasing IT dependence, the increased focus on industry-wide resilience is critical.

However, the excessive regulatory burden has arisen not so much from the legislation itself as from the rigid and overly bureaucratic way it has been implemented and enforced by the UK regulators. Their driving objective is to avoid criticism for regulatory failures, with little incentive to balance that against regulatory costs.

Rather than regulating through a small group of senior supervisors, the regulators employ a growing army of less experienced staff who are more likely to stick to a rigid interpretation of the rule book because they do not have the confidence or experience to take responsibility for balanced supervisory judgments.

The senior managers approval regime, for example, is in principle a sensible safeguard to avoid inappropriate appointments to senior positions. However, where a major institution has gone through a careful and rigorous recruitment process, it causes damaging delay to then have less qualified staff in both regulators repeat the process to grant approvals.

Similarly, while accountability is important, the desire of the regulators to pin every mistake on an individual and to demand consequential penalties has had a corrosive impact on the willingness of executives to take tough decisions, creating bureaucratic gridlock as they seek to share responsibility.

Another consequence has often been blanket “one size fits all” implementation, with disproportionate costs to many participants. The ringfencing of retail bank deposits away from other higher risk banking activities was a sensible reform in principle, but the implementation has imposed costly structures and governance bureaucracies on banks with quite limited investment banking exposures.

In the case of the Financial Conduct Authority, its desire to protect customers from any adverse outcome has had the counterproductive effect of adding significant costs to many financial products.

The dual structure of the FCA and the Prudential Regulation Authority means both bodies pursue their own agendas, sometimes imposing conflicting priorities on financial institutions without sufficient consideration of the overall regulatory burden. Unfortunately, both institutions continue to resist the idea of joint supervisory teams.

The introduction in this bill of a secondary objective — for the regulators to consider the competitiveness of the financial services industry — is an important recognition of the need for some rebalancing. However, on its own it is unlikely to have a significant impact on the regulators’ culture and practices.

That will need a much more fundamental reappraisal of the regulatory landscape and a recognition within the regulators themselves of the need for radical change. Without that, the regulatory overhead is likely to continue to grow unabated, with damaging consequences for the competitiveness and economic contribution of the UK’s financial services sector.