(Reuters) - Chancellor Alistair Darling on Friday spelled out plans to strengthen bank regulation to avoid a repeat of the crisis at mortgage lender Northern Rock, including giving regulators more powers to intervene early.
Following is an explanation of how Britain regulates banks:
** Who regulates British banks?
A so-called “tripartite arrangement” divides responsibility for regulating banks and the wider financial system between the Treasury, the Bank of England and the Financial Services Authority.
The Treasury is responsible for the overall institutional structure of regulation and provides the link between the regulating authorities and government.
The Bank of England is responsible for assessing the robustness of financial markets and overseeing the financial system’s infrastructure, including the payments system.
The FSA is responsible for the authorisation and supervision of individual banks, building societies, insurers and other financial firms, and for the supervision of financial markets.
** What happens in a crisis?
Crisis management is focused on the Tripartite Standing Committee, chaired by the Treasury and including the Chancellor, the governor of the Bank of England and the chairman of the FSA.
The Bank of England’s responsibilities in a crisis include assessing the robustness of financial markets, and, crucially, providing emergency assistance to individual firms or the market, in its capacity as “lender of last resort”.
In a crisis, the Treasury provides the link with wider government. The Chancellor decides whether or not to commit public funds, aided by assessments from the Bank and the FSA.
Under widely expected changes outlined by the Chancellor on Friday, new rules for crisis management could give the FSA the power to step in if a bank is in trouble, to protect deposits and prevent a run. The “lender of last resort” facility may also come with strings attached — a reorganisation of any bank in trouble, for example.
There will also be changes to Britain’s insolvency regime for banks, currently the same as for other companies.
** What does “lender of last resort” mean?
Being the “lender of last resort” is one of the BoE’s key roles in a crisis, when it can step in with emergency funds to limit the risk of problems spreading beyond one institution to the wider financial sector.
The Chancellor can refuse a support operation.
In the case of Northern Rock, the public nature of the “lender of last resort” facility effectively triggered a run on the bank, prompting calls for a review of how the tool is used.
Bank of England Governor Mervyn King has said he would have liked to offer Northern Rock the lifeline in secret, but was prevented by rules including Market Abuse legislation.
** Who guarantees Britain’s bank deposits in a crisis?
The safety net for Britain’s savers has been one of the key topics for debate since the run on deposits at Northern Rock.
Until the crisis, under Britain’s industry-funded Financial Services Compensation Scheme only the first 31,700 pounds of savings were guaranteed — 100 percent of the first 2,000 pounds and 90 percent of the next 33,000 pounds.
In October, the 100 percent guarantee threshold was lifted to 35,000 pounds. That could be raised again, with limits as high as 100,000 pounds currently being debated.
Unlike its pre-funded U.S. counterpart, the UK scheme is funded on a “pay-as-you-go” basis by financial institutions.
** What about liquidity?
Liquidity, or lack of it, is typically the cause of banking failures and is one of the key risks for the sector.
But it is notoriously hard to measure and regulate, and banking rulebooks, including Basel II, have focused largely on banks’ capital requirements and solvency.
In Northern Rock’s case, this meant that despite a reliance on wholesale markets, it was not required to hold cash beyond the UK sector minimum — enough to survive at least five working days without tapping wholesale markets and to cover customer withdrawals equivalent to 5 percent of retail deposits.
The FSA issued a discussion paper on liquidity last month, telling banks to carry out tougher tests to ensure they can withstand shocks, draw up better contingency plans and update regulators more frequently.
Formal proposals on changes to the regime are due this summer but the Chancellor said in Friday’s comments that the FSA will get more powers to ensure liquidity requirements are met.