Parliamentary Connections

The Prime Minister has looked weak and ineffectual in his increasingly pathetic pleas to the banks to abandon bonuses. The public believes it owns several of the banks - it does - and it thinks that with ownership should come a degree of control. Unfortunately, the government didn't make the same connection when it threw billions of pounds of taxpayers' money at the crisis-ridden sector and shows no sign of grasping the credibility gap that yawns ever wider as public anger over bonuses grows.

The banks that are now dependent on public money for survival should be answerable to Parliament. I stick to my view that the best mechanism for this would be a new select committee chaired by Vince Cable with real powers to hold the banks to account. Alongside side this there should be government-appointed directors on the banks' boards, not former bankers tainted by the years of mis-management that led up to the near collapse of the sector but genuinely independent directors empowered to hold the professionals to account.

Which? used a recent survey to illustrate how far consumer confidence had been rocked over the last few months. Here are a few figures from that survey:

• 84% think the banking system needs to be reformed to avoid another crisis.

• 21% do not trust banks to keep their money safe.

• 72% of pension holders are worried about the value of their pension.

• 35% of current mortgage holders are worried about having their home repossessed.

There are plenty more in the full presentationWhich APPG presentation.ppt

Consumers need to be confident that their money is safe, said Which?, as the current situation is bad for consumers and bad for the financial services industry. The whole system cannot function without trust and the focus has to be on restoring that lost trust starting with getting the banks - especially those relying on taxpayer support - to treat customers fairly. Which? was particularly critical of the failure of banks to manage the contraction of credit which it attacked as going "from feast to famine".

It also called for a stronger voice for consumers in the running of the nationalised and part-nationalised banks, starting with representation on UK Financial Investments which has been set-up by the Chancellor of the Exchequer to oversee these unwanted - at least unsought-after - state holdings.

All predictable stuff, as was the assertion that regulation needs to be stronger, more probing and much more consumer-focussed. Which?, went further than this, however, spelling out where it thought the fundamental faults with the current regime lay.

Firstly, it called for a separation of retail and investment banking, a call for a return to the days of the US Glass-Steagall Act which kept the riskier end of wholesale and investment banking away from what we used to call the clearing banks: cross-ownership was prohibited in the US which effectively put a block on it elsewhere in the world. When this Act, passed in the wake of the Great Crash of 1929, was swept away in 1999 the seeds of the current crisis were sown, argued Which?. The high risk addiction of the investment banks replaced the innate caution of the very traditional retail banking sector.

The second fault line Which? drew to the attention of MPs contains the irreconcilable conflict between prudential supervision and consumer protection. The thrust of Which's argument as it emerged in discussion with the Parliamentarians at the meeting was that if the number one priority is solvency then decisions will be made that will not be in the interest of consumers, essentially where we are today with the brutal shut-down of credit destroying the mortgage market and other lines of consumer and business credit. This would require a total reform of the regulatory regime put in place after Labour came to power in 1997 and which has the broadly based Financial Services Authority at it heart. Which? would like to see prudential regulation handed to a freshly empowered Bank of England with the FSA left to concentrate on a more consumer orientated role.

This is an interesting analysis and one that will, I am sure, emerge from elsewhere as the debate about what happened, why it happened and how the current system of regulation allowed it to happen gathers momentum. Whether it is entirely right I have some doubts. As unpalatable as it is to most in the UK financial services sector I still think that we will find ourselves looking at some form of product regulation more along mainstream European lines as the most direct and effective way of convincing consumers that regulators have really taken control of the problem. The irony of this is that we in the UK have fought hard over the last 20 years - ever since the run-up to the creation of the Single Market in 1992 - to convince the rest of Europe that prudential regulation was the way forward and that product regulation was not in the interests of consumers. It is an argument that now looks threadbare.

It will be an interesting battle. Gordon Brown shows few signs of admitting that the system of regulation he put in place in the early days of the Labour government was deeply flawed. I have seen reports suggesting that the Prime Minister has "relaxed" his opposition to more Europe-wide regulation but I don't see that reflected in anything he says. At the weekend, he was critical of proposals - gathering pace on both sides of the Atlantic - to restore the split between retail and investment banking. It does seem that he just cannot bring himself to admit that anything he has done or supported in the past has been wrong.

He will oppose the creation of any pan-European regulator once it becomes clear that it wants to approach regulation in a different way to that he put in place in the UK. This will leave the UK very isolated as the rest of Europe sees our system as being the most deeply flawed which is why we have the most serious problems.

It is, of course, no more than one would expect of the FSA's bosses to own up to the mistakes of the past. After all, the wreckage of the financial system lies all around us, grim witness to the total failure of a light touch regulatory system bullishly promoted here and in the USA. Also, on the very day that the European Commission made its pitch to take over regulation you would expect the FSA to come out fighting.

A more detailed consideration of what Lord Turner said yesterday does suggest that there is much more going on behind the scenes than they are being given credit for. Whether it is enough to preserve the FSA's key position in the regulatory firmament is by no means clear but it does point the way to a fundamental shift in its approach to financial regulation and, crucially, aligns it more closely with European thinking and the consumer lobby in the UK.

The commitment to embrace product regulation is a rejection of the last 25 years of financial regulation in this country. Ever since the unfettered free market regime of Margaret Thatcher in the 1980s and the battle with the European Union in the run-up to the creation of the single market in 1992, product regulation has been dismissed in this country as the great inhibitor of dynamism and growth in financial services. We won that battle in Europe and Solvency II is one of the products of that regime where all the emphasis is on capital adequacy and balance sheets, ignoring the products. The European Commission wants Solvency II fully implemented by May. Why? So that it can clear the decks for an assault on the products of financial institutions. The FSA is foreshadowing this.

Don't run away with the idea that the FSA is just looking at the high risk financial instruments of the investment banks when it talks about product regulation. The example it offered yesterday was mortgages where Lord Turner suggested that capping loan-to-value at 80% or 85% might be something the FSA should do.

The other clue as to the FSA's thinking was the promise to increase "by several times" the amount of capital that banks must hold to cover the riskier end of their trading books. This seems to be a way of separating retail and investment banking by stealth. The FSA seems to saying that if it can't move quickly - because the Prime Minister doesn't accept the case - to separate retail and investment banking, then it will do it by imposing tough capital rules that will make it attractive for some institutions to back away from investment banking. This is probably the route that Royal Bank of Scotland will go down later today.