Page last updated at 09:38 GMT, Friday, 31 July 2009 10:38 UK

Banking reform 'largely cosmetic'

Alistair Darling
The Chancellor wants to maintain the current tripartite regulatory system

The government's plans for reforming the regulation of banks are "largely cosmetic" and "lack clarity", MPs in the Treasury Select Committee say.

In its report on the banking crisis, the committee says that responsibility for strategic decisions and action remains "a muddle".

The report also says that the Financial Services Authority (FSA) "failed spectacularly" in supervising banks.

The FSA said it has "changed radically" since an internal review in 2008.

Earlier this month, Chancellor Alistair Darling said banks would face tougher regulation and consumers would get more protection.

The reforms are specifically designed to try to prevent the current financial crisis happening again.

The most important parts of the report relate to ... the best ways of shrinking banks individually and collectively so that they can no longer hold the taxpayer to ransom
Robert Peston, BBC business editor

But the plans have been criticised for not going far enough.

For example, the current tripartite system, where the Bank of England, the Treasury and the FSA oversee the financial system, would remain intact.

The Tories want to abolish the system and hand more power to the Bank of England.

'Extremely perturbed'

The Treasury Committee report, entitled Banking Crisis: Regulation and Supervision, does not advocate "substantial change" to the tripartite system.

Where responsibility lies for strategic decisions and executive action was, and remains, a muddle
Treasury Select Committee

But it does criticise the government's reform plans.

The report "considers the reforms to the institutional structure of the Tripartite Committee to be largely cosmetic. Merely rebranding the committee will do little in itself".

The real problem lies in the fact that responsibilities are not properly allocated, it argues.

"Where responsibility lies for strategic decisions and executive action was, and remains, a muddle," it says.

It also highlights a lack of co-ordination and admits to being "extremely perturbed" by evidence from Mervyn King, Governor of the Bank of England, that he had "no idea" of what the government's plans for reform were.

John McFall, the chairman of the Treasury Select Committee, said: "Change and co-ordination are needed to clarify responsibilities."

'Develop teeth'

The report also criticised the FSA's response to the crisis.

We should not rule out more drastic action, such as forcibly shrinking the banks or separating out the riskier functions
John McFall, chairman of the Treasury Select Committee

"By any measure, the FSA has failed spectacularly in its supervision of the banking sector," says Mr McFall.

But the he does acknowledge that the authority has "already begun to rectify its mistakes" and is now "moving in the right direction".

The committee says the body must be strong enough to stand up to the vested interests of the City.

It must "develop sufficient teeth to be able to go against the tide in the future and take unpopular decisions", says Mr McFall.

Responding to the report's findings, the FSA says it has "changed radically" since early 2008, and has "identified and rectified its historic mistakes".

'Drastic action'

Finally, the report argues that the government must ensure that no bank is too big to fail.

The government has bailed out Northern Rock, Royal Bank of Scotland and Lloyds Banking Group, arguing that letting any of them fail would threaten the entire financial system.

The report says that no bank should be allowed to take risky bets in the knowledge that it will be bailed out by the government should those bets go wrong.

"Tweaking the capital requirements to prevent this happening may work, but we should not rule out more drastic action, such as forcibly shrinking the banks or separating out the riskier functions," says Mr McFall.

The report even suggests that this "market failure" be addressed by a "tax on size".

The committee also argues that prohibiting deposit-taking banks from making risky investments should not be ruled out at this stage.

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