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LONDON (Reuters) - British financial firms need to respect the spirit, and not just the letter, of rules designed to prevent another financial crisis, one of the central bank's deputy governors said on Monday.
Sam Woods, who is in charge of the BoE's day-to-day regulation of banks and insurers, said fixed rules could never keep up with financial market innovation, and that the central bank also expected firms to respect broader principles designed to reduce risk.
"Some innovation is pure regulatory arbitrage - that is, action taken by firms to reduce specific regulatory requirements without any commensurate reduction in their risk," Woods said.
His remarks were originally intended for a conference of Britain's Building Society Association in May, but the BoE delayed publication until Monday to avoid clashing with campaigning for June's parliamentary election.
Last week the BoE said it would take a tougher approach towards banks over their booming lending to consumers, ordering them to apply credit rules prudently and prove by September they are not being too complacent about risks.
Woods said there were several areas where he had particular concerns that financial firms were trying to get around rules. These included borrowing that did not appear on firms' balance sheets, the accounting treatment of liquid assets, and insurers' sales of certain savings products.
Shrinking net interest margins at building societies in the face of greater competition were also a worry, Woods said, as they could spur lenders to take on too much risk.
Something similar took place in the run-up to the 2007-09 financial crisis, Woods said. One concerning trend was the increased number of mortgages issued for 35 years, not 25, he added.
"As survivors, (building) societies here today ought to be well aware of the warning signs, but I'm conscious that corporate memories can be shed surprisingly fast," Woods said.
Reporting by David Milliken; Editing by Gareth Jones