Compliance News - 30 September 2011
Ensuring greater financial stability may require policy makers to make judgements about the right level of credit in the economy, and about the relative value of different categories of credit created by the banking system, said Adair Turner, chairman of the FSA at a speech given 29 September 2011.
Speaking at a European conference on banking and the economy at Southampton University, Lord Turner said that the financial crisis had in part derived from new features of the financial system, such as trading in complex credit securities and derivatives, and argued that further regulatory action to address the risks created by these activities was still required. He highlighted further changes to the capital regime for trading activities, and the international Financial Stability Board’s project to identify required actions in relation to “shadow banking”. But he stressed that banking crises and harmful swings in economic activity can also be produced by volatility in the core functions of the banking system such as extending loans to customers. In the case of the major banks which had failed in the UK, failures in plain old fashioned banking were as important as failures in new trading activities.
Lord Turner said:
''Alongside thinking out our response to what was new in the latest crisis, we must ensure that we have thought deeply enough about the drivers of excessive credit growth in the upswing, and the problems created by deficient credit growth in the post-crisis period, and about possible policy responses.''
Lord Turner set out theoretical and empirical reasons that suggest that if credit supply to the economy was left to its own devices it could result in harmful booms and busts in credit extension. He suggests that a combination of static micro-prudential regulation (constant capital and liquidity rules) and interest rate policies cannot be sufficient to ensure the level of credit supplied to sectors of the economy is optimal from a social point of view.
He argues that macro-prudential policy levers, such as those for which the new Financial Policy Committee would be responsible, could therefore be vital in creating the optimal level of credit in the economy. Lord Turner suggests these tools could include counter-cyclical capital requirements or loan-to-value ratios on mortgages varying over the cycle. While recognising that further detailed design work was required, he argued that it was likely that tools could be developed which would effectively lean against the upswing of credit booms and asset price cycles.
The more difficult question, he suggested, was whether macro-prudential levers could help address the current priority; the need to stimulate the economy rather than to restrain it, or whether macro-prudential policy like interest rates policy was ''pushing on a string.''
Lord Turner said:
''A crucial issue at this point in the cycle is, therefore, whether macro-prudential policy has a role to play in stimulating rather than constraining credit supply and demand, whether it can be used to ''push'' as well as to “pull''. The answer is unclear. But what is clear is that if we are to use macro-prudential policy levers to push, we may need to get far more involved in the details of credit capacity within the economy and even of the sectoral allocation of credit, than we have for several decades.''
Lord Turner concluded:
''We should be very cautious of expecting too much of macro-prudential policy: if it manages to dampen the excesses of the upswing of the credit cycle, that in itself will be a major achievement, making future downswings less harmful. But we certainly need to base macro-prudential policy and other aspects of policy on realistic assessments of the extent to which private credit creation processes can be relied upon to be socially optimal.
''The fundamental question which I have asked is: how confident can we be that the quantity of credit supplied and demanded will be socially optimal. The answer is not very confident. That implies that macro-prudential policy must be based on judgements about the optimal aggregate quantity of credit creation and that we need to consider carefully how far we can and should, make judgements about the economic value of different categories of credit, which in the recent past we have largely avoided.''
Source: Financial Services Authority
The FSA fined Towry Investment Management Ltd £494,000 for providing incorrect information to the FSA and client money failures.
The FSA set out its rules on how firms need to treat client money in its Client Asset Sourcebook (CASS). As part of its work to ensure that firms comply with CASS requirements the FSA sent a Dear CEO letter to relevant firms asking for checks to be undertaken to ensure firms understood, and were fully compliant with, the rules.
In its response to the Dear CEO letter Towry stated that it was fully compliant. Towry failed to ensure the response was properly considered before submitting it to the FSA. The reality was that the firm was not compliant and this only became apparent after the FSA, as part of a CASS visit to the firm, discovered the breaches.
Towry’s failure to provide an accurate response to the FSA on this important issue was a breach of Principle 11, which requires firms to deal with the FSA in an open and cooperative manner. The failure of the firm to treat client money in the correct way breached Principle 10.
The FSA considers Towry’s failings to be particularly serious for the following reasons:
· Dear CEO letters are an important regulatory tool used by the FSA to raise significant issues and firms must consider them with particular care;
· The firm failed to ensure the response to the Dear CEO letter was properly considered and checked before being sent, resulting in inaccurate information being provided to the FSA;
· Towry’s CASS breaches could have placed clients’ money at risk of potential loss or delay in distribution if the firm had become insolvent because it failed to maintain adequate records;
· Towry failed to identify the breaches itself. Instead, the matters came to the FSA’s attention during an FSA visit to the firm in November 2010; and
· There has been a high level of awareness in the financial services industry of the importance of handling client money properly since the collapse of Lehman Brothers on 15 September 2008 and failure to do so is not acceptable.
Towry agreed to settle at an early stage entitling it to a 30% discount on its fine.
Tracey McDermott, acting FSA director of enforcement and financial crime, said:
Tracey McDermott, acting FSA director of enforcement and financial crime, said:
''Open and accurate communication with the FSA is of fundamental importance to the functioning of the regulatory system. It should go without saying that taking steps to ensure information provided to us is properly considered, up to date and correct is a basic regulatory requirement.
''It is very disappointing that Towry failed to do so particularly in an area of such regulatory importance. Firms should be in no doubt about how seriously we regard such failures.''
The protection of client money and custody assets (client assets) is a regulatory priority. The FSA’s response to the financial crisis and the issues it uncovered was to increase the level of resource devoted to the protection of client assets. The FSA established the Client Asset Unit to lead specialist and intensive supervision of client assets and improve compliance with the aim of ensuring that firms have robust systems in place to ensure the swift return of client assets and money in the event of firm insolvency.
Source: Financial Services Authority
FSA PUBLISHES PS11/11 - USE OF NON-EEA RULES IN CALCULATING GROUP CAPITAL REQUIREMENTS – FEEDBACK ON CP11/6 AND FINAL RULES
This paper reports on the main issues arising from Consultation Paper 11/6 (Use of non-EEA rules in calculating group capital requirements) and publishes final rules. This will be of interest to banks, building societies and BIPRU investment firms that are part of UK consolidation groups which have subsidiaries in jurisdictions outside the European Economic Area (EEA).
Source: Financial Services Authority
The OFT has published guidance for businesses when they are considering granting credit to people who might not have the mental capacity to make informed borrowing decisions.
It sets out steps that the OFT expects consumer credit businesses to take with a view to:
- identifying borrowers who might have mental capacity limitations
- assisting them to understand credit agreements so they can make informed borrowing decisions
- reducing the risk that they will be granted unaffordable or clearly unsuitable credit.
The guidance focuses primarily on creditors adopting appropriate practices and procedures to assist borrowers who might not have the mental capacity to make informed decisions. These include:
- providing borrowers with clear information and explanations about credit agreements and any associated risks
- giving them adequate time to weigh up the information and explanations provided in order to better enable them to reach responsible borrowing decisions
- carrying out sufficiently stringent assessments of their ability to afford to meet repayments in a sustainable manner.
David Fisher, Director of the OFT's Consumer Credit Group, said:
'This is a sensitive area. In producing this guidance, we aim to provide clarity for creditors as to what the OFT expects of them and to afford better protection to a particularly vulnerable group of people, whilst ensuring that they are not inappropriately denied credit.
'It is important to balance the right of a person to make a decision, with their right to safety and protection when they can't make decisions to protect themselves.'
Source: Office of Fair Trading
