Page last updated at 14:16 GMT, Wednesday, 18 March 2009

At-a-glance: Banking reform

Northern Rock clock
Poor regulation played a part in Northern Rock's demise

Proposals aimed at overhauling UK banking rules and stopping a repeat of the financial crisis have been unveiled by Lord Turner, the head of the City watchdog, the Financial Services Authority (FSA)

Here's a brief run-down of some of what his report proposes, and the problems it hopes different measures will solve.


Why: The FSA has admitted not doing enough to anticipate the financial crisis. A "light touch" in regulation was seen as appealing but the system failed to look at what the banks were doing and it missed "systemic risks". Regulators concentrated on minor issues rather than the bigger picture meaning that some business models, described by BBC business editor Robert Peston as "barmy", were unquestioned. As a result, banks collapsed.

Proposal: Intense supervision of banks with "soft touch regulation consigned to the dustbin of history". The possibility of a giant Europe-wide body to regulate banks within the European Union, which would set a Europe-wide standard for regulation. Better monitoring of the credit conditions of the economy - to be done by the FSA, the bank of England and the International Monetary Fund.

Why?: Northern Rock, Bradford & Bingley, Alliance and Leicester and HBOS were hugely reliant on the permanent availability of cheap money from the credit markets to run their business models. When credit markets dried up, the banks ran into serious trouble and needed bailing out or nationalising.

Proposal: Banks being forced to hold much more cash so that they can cope if their usual source of finance dries up, allowing them to carry on with their business without needing taxpayer help.


Why?: High bonuses have created incentives for some executives and traders to take excessive risks. Some have received large payments in reward for activities that may have seemed profit-making at the time but have ultimately led to large losses being racked up, proving harmful to banks and other institutions.

Proposal: Remuneration policies should be designed to avoid incentives for undue risk taking. Bonuses should be deferred, so that if activities do go wrong, this is reflected in payouts. This would reward long-term success.


Why?: The availabilities of mortgages at very high initial loan-to-value ratios - sometimes as high as 125% of the value of the property - allowed more people to get on the housing ladder. Both borrowers and lenders assumed that property prices would continue to rise. Falling house prices have left many householders in negative equity or unable to repay loans while the banks have bad debt and are forced to repossess.

Proposal: No recommendations, but calls for debate on whether more effective regulation of the mortgage market is needed - considering if there should be limits on the types and sizes of loans that should be available.


Why?: Hedge funds are largely unregulated. Attracting wealthy investors, they generally make more complicated and higher-risk investments than traditional investment funds. They typically borrow money to maximise their positions, but this means they are particularly vulnerable to any sudden market crisis as they have to meet lenders' demands. Their need to sell off shares to raise funds can add to falling markets.

Proposal: More stringent controls on so-called "shadow banking", with unregulated firms like hedge funds required to increase reporting on their activities to monitor widespread risk and how their dealings could impact on the broader financial sector.


Why? Banks not having enough capital left them vulnerable to shocks. They were also unable to maintain the supply of credit - for example loans to small businesses - exacerbating the recession.

Proposal: Creating capital buffers, building up capital in good economic times so that they can be drawn on during downturns. This would make them less profitable but more able to weather storms such as the credit crunch.

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