The end of the road for the FSA?

The Conservatives have outlined plans to abolish the Financial Services Authority, throwing the chief City watchdog into disarray. Deputy Business Editor James Moore reports

J ust over a decade after its creation from the single most complex piece of legislation yet seen in Britain, the Financial Services Authority could now be on its last legs.

Tory leader David Cameron yesterday said that if, as the polls predict, he becomes the next Prime Minister, he will scrap Britain's single financial regulator and hand its most important powers to the Bank of England. A separate consumer watchdog will be created by combining much of what remains with the Office of Fair Trading.

The Bank's Governor, Mervyn King, could then emerge as the long-term winner of the unseemly turf war with the FSA and the Treasury over who should do what in the wake of the ongoing financial crisis that continues to shake Britain's economy. Cameron said: "This crisis has shown we need one body to be unambiguously in charge – always on top of things. That body must have the expertise and authority to regulate the overall amount of debt in our economy. That body must use its discretion and judgement, not follow rules and tick boxes. That body must have the respect and the influence to keep our banks in check. In the United States, they've called on the Federal Reserve. In Britain, it's time to call on the Bank of England."

Of course, the problem with this is that the Bank will desperately need the expertise of the FSA's banking supervisors if it is to fulfill this role effectively and, if the FSA's best people react to yesterday's announcement by heading for the exit, the Bank and an incoming Conservative government will face a big problem.

Publicly the FSA has no choice but to grin and bear it. Yesterday, it said: "The FSA's current responsibility is to ensure effective prudential supervision and consumer protection, and we believe that our integrated approach to understanding the whole business models of banks and other financial institutions helps to achieve that. We will continue to implement the major reforms to the supervisory process and to regulation required to build a sounder financial system, as set out in the FSA's Supervisory Enhancement Programme in the Turner Review. Should any future government wish to make changes to our remit, we would, of course, work to ensure a smooth transition to any new arrangements."

But management have already felt the need to send reassuring e-mails to staff, because it is clear that the Conservatives' plans are having a deeply destabilising effect at the worst possible time. With talks about global regulatory reforms ongoing, Britain's watchdog also risks being seen as a busted flush.

An FSA insider said yesterday: "It would be a bitter irony if we were to get broken up just as we've finished reforming ourselves."

Reaction to the Tory plans was mixed. The British Bankers' Association was cautious: "UK banks have already made significant moves to reform how they operate and major capital reform is underway. Banks are holding far more capital than is required under international rules and are looking to how they would survive any future financial crash. But change needs to be properly and systematically managed. It has to be taken internationally and must be proportionate to ensure stability, rather than simply chopping banks up. We need to take care we do not stifle the financial sector through an effective tax on the size of businesses as scale is important for innovation, lower costs, financial inclusion and international business."

Richard Lambert, director general of the CBI, also gave the plans a lukewarm response. He said: "This is a very radical blueprint. The Conservative proposals would give the Bank of England the most wide-ranging powers of any central bank in the major economies.

"What most concerns business is what regulators do, rather than where they sit, and lots of big questions remain unanswered in these proposals. They include issues such as how the transition to a new structure would be managed, who would be responsible for markets and securities regulation, and whether the Bank would have the capacity to carry out all of its new functions."

At the same time the Liberal Democrats weighed in with proposals of their own. Some might be tempted to dismiss these with the standard refrain of "well, they'll never get in power will they?". However, it is worth remembering that, in the event of a hung Parliament, it is not beyond the bounds of possibility that their widely respected and influential Treasury spokesman, Vince Cable, could become Chancellor.

The Lib Dems would keep the FSA but give the Bank of England overall responsibility for financial stability, with the power to compel the FSA to act. Dr Cable also wants to see a break up of Lloyds and Royal Bank of Scotland, among other proposals.

But putting money on a hung Parliament is a risky bet and it is unlikely that the FSA's best staff will be willing to stake their futures on it.

Conservative sources were last night seeking to reassure FSA staff that their status would be enhanced under the Bank. There was even an explicit pledge that the levy banks pay for regulation will be increased – with the aim of paying regulators more. They had better hope this works, otherwise there might not be any regulators left if, and when, they take power.

Shaking up banking: The parties' plans

Conservatives

*FSA to be abolished.

*Bank of England to take over responsibility for banking regulation; new Financial Policy Committee to oversee banking system along the lines of Monetary Policy Committee. Its minutes to be published.

*Beefed-up Bank to have powers to oversee pay, risk levels and size of banks.

*New consumer protection watchdog incorporating roles of the FSA and Office of Fair Trading with power to name and shame miscreants and to force banks to be more transparent on consumer charges.

*OFT and Competition Commission to review banking competitiveness and whether to break up Lloyds and Royal Bank of Scotland.

*Competitiveness to be a key consideration in sale of government stakes; they will not necessarily be sold to highest bidder.

*Banks seen to be encouraging risky practices through pay policies to be forced to hold more capital

*Pledge to consult internationally over whether retail banks should be allowed to engage in risky investment banking activities.

*Treasury minister to be appointed with special responsibility for "fighting our corner in Brussels" so that European regulations are right for the City of London.

Liberal Democrats

*FSA to retain role as unitary regulator, but tripartite supervision of banks to be altered, with Bank of England to chair Financial Stability Committee with power to force FSA to take action where there is seen to be danger.

*Firm pledge to break up RBS and Lloyds before government stakes sold.

*Bankers earning in excess of £200,000 to be forced to publish details of their pay. Requirement that they are resident and domiciled in UK for taxation purposes.

*State to retain a long-term role in banking; pledge that there will be "no quick sale" of government stakes.

*Asset Guarantee Scheme under which state guarantees billions of pounds of risky loans to be scrapped.

*Penalties for banks which try to get around new regulatory rules.

*Fines for banks that fail to reform their pay policies.

*Banks in which the Government holds a stake to be forced to lend more.

Labour

*FSA to retain its role, with new powers. Strengthened tripartite supervision; Treasury to chair Financial Stability Committee including FSA and Bank of England.

*Staged sell-off of bank stakes to highest bidders; no pressure for quick sale but first could happen within a year.

*Banks engaging in risky activities must set aside more capital, policed by FSA.

*Walker review on the governance of bank to be accepted in full.