Page last updated at 17:48 GMT, Friday, 17 April 2009 18:48 UK

FSA defends Dunfermline oversight

Lord Turner
The FSA has already suggested improvements to financial regulation

The Financial Services Authority (FSA) has defended its regulation of the Dunfermline building society.

The society was taken over last month, by the Nationwide building society and the Treasury, to stop it going bust.

The FSA has been accused by an anonymous former member of staff of regulating societies complacently.

But in a letter to the Chancellor Alistair Darling, the FSA reveals it had been scrutinising the society's commercial property loans since 2005.

The FSA's chairman, Lord Turner, argues that tougher rules on lending, rather than more detailed supervision, are the solution to any such problems.

"I suggest that the causes of the Dunfermline failure highlight the need for the major reforms to the capital adequacy rules and macro-prudential analysis set out in The Turner Review," Lord Turner says in his letter.

"Nor do I currently believe that [enhanced supervision] should be redesigned to try to prevent such problems via even more intense firm-level supervision," he adds.

One of Lord Turner's preferred solutions would be to stop building societies making loans to commercial property developers, because societies do not have enough skill to judge the risks involved.

Loan book

The FSA's letter to the chancellor says the Dunfermline's problems lay mainly with its commercial property loans, which rose from £112m in 2004 to £628m in 2008.

There was no immediate problem: the problems related to future possible solvency under stressed conditions
FSA letter

But even as late as December 2007, the society's own auditors suggested the provisions which had already made for potential bad debts might in fact be higher than necessary.

As the worldwide financial crisis grew during 2008, the FSA took a much closer look at the finances of all the UK's building societies.

And in October last year its worries about the Dunfermline crystallized when it worked out that the society would not be able to meet "future possible severe losses" without having more money in reserve.

At that stage the FSA calculated that the society needed to raise a further £20m to bolster its reserves.

"At the same time, the FSA was beginning to have concerns about the ability of the society's management to cope with the more turbulent conditions which the whole industry was by then facing," the FSA's chairman Lord Turner wrote in his letter.

Potentially insolvent

Just a few months later, in March this year, the FSA "stress tested" the society's loans again.

It came to the conclusion that potential losses on its commercial loans - which it admits would have to be much larger than current levels of arrears or other indicators suggest are likely - meant then even an injection of £60m would be insufficient to guarantee its solvency for more than another two years.

"It is worth noting that in liquidity [cash flow] terms there was no immediate problem: the problems related to future possible solvency under stressed conditions," the FSA explained.

Meanwhile the FSA tried, but failed, to organise a takeover involving one of three other building societies, or the injection of cash from a consortium of societies under the auspices of the Building Societies Association (BSA).

In the end these came to nothing and the authorities used their new powers under the 2009 Banking Act to push through a rescue deal.

As a result the Nationwide has taken over the Dunfermline's branches, good loans and deposits.

The Treasury has taken on about £1.5bn of commercial property loans and mortgages bought from other lenders.

A new code of practice for building societies will be issued by the FSA in July, to make them more cautious about lending that is not secured on residential property.

Lord Turner's letter repeats some of the points made in his review, published in March, which recommended that the Bank of England and the FSA should improve their analysis of any risks building up in the financial system.

The review also said financial institutions should be obliged to put aside more money in the good times as an improved buffer against losses during economic downturns.

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