One positive thing about the NR affair

The Financial Services Authority\'s report into its handling of the Northern Rock crisis reveals some startling facts. But rather than rake over the litany of its errors, there is a case for defending the regulator.

According to its website, the FSA “regulates the financial services industry and has four objectives under the Financial Services and Markets Act 2000 – maintaining market confidence, promoting public understanding of the fi-nancial system, securing the appropriate degree of protection for consumers and fighting financial crime”.

All these aims are laudable but none extend to protecting banks from failure. Only ‘maintaining market confidence’ could arguably be interpreted as including keeping banks solvent. Indeed, the FSA’s internal audit suggests that it assumed the Bank of England would step in if the solvency of a bank was in question.

By its own admission, the FSA has been consumer fo-cussed at the expense of understanding the details underlying banks’ operations. So it is hardly surprising and even forgivable that it failed to predict the effect of a global liquid-ity crisis on a sensitive business model.

That said, some of the findings in the report are damning. Its failure to minute meetings and ensure staff continuity suggests that every NR branch in the country could have spontaneously combusted without comment.

But these failings relate to internal operational efficiency rather than fundamental mistakes in decision-making. The FSA is guilty of failing to recognise warning signs but it would be more serious if it had noted warning signs and decided not to act.

As it is, the FSA seems focussed on liquidity and the minutiae of treasury desk operations in banks and societies. I hope its principles-based approach will not be cast aside in favour of overbearing regulation. Free markets operate more efficiently when left to themselves, despite re-cent events seeming to indicate the opposite.

On another positive note, the FSA’s handling of events following the downfall of NR has been encouraging.

FSA chief executive Hector Sants says: “Demonstrating our willingness to examine ourselves critically and learn lessons is central to giving the financial services industry and consumers confidence in the FSA, although we cannot and do not claim infallibility and we cannot and should not attempt to remove all risk from the system.”

The FSA could have done nothing to avert the global liquidity crisis and it is unlikely that even heavy-handed early intervention would have saved NR. If, as a result of the NR affair, we get a smarter regulator that retains a light touch, at least one good thing will have come out of it.