The system of banking regulation under which BCCI failed has been revamped over the past 14 years to cut the risk of big institutions sliding into disaster.
Regulatory philosophies and collaboration between national watchdogs have advanced, but the starkest change is that the Bank of England is no longer responsible for banking supervision.
Not every reform can be linked to the lessons of BCCI – or indeed the Barings collapse four years later – but the bank’s failure served to expose weaknesses in a supervisory system led by the Bank. Following a long-running debate as to whether the central bank should supervise financial institutions, the Labour government decided in 1997 to transfer responsibility for banking regulation to the Financial Services Authority, the newly created City watchdog.
The move was partly a knock-on effect of the government’s decision to give the Bank independent control over interest rates, a task that could conflict with banking regulation.
It would have been anachronistic to leave one supervisory role outside the FSA: the regulator was created to consolidate functions previously performed by a disparate group of bodies, thereby closing potential loopholes and improving efficiency.
Under the Bank, regulation was said to be based largely on personal relationships and trust between banks and Threadneedle Street supervisors. Since then banking regulation has become more sophisticated and data-intensive.
The FSA relies more on hard figures to tell the story of liquidity, capital strength and risk management at the institutions it controls. Medium-sized groups are monitored by individual FSA supervisors, while “high-impact” institutions such as Barclays or HSBC are tracked continuously by a team of four or five people.
David Lascelles, co-director of the Centre for the Study of Financial Innovation, said the FSA was better equipped than the Bank to investigate and take action against problematic institutions. “The Bank had very few powers to go and get information. It only had the nuclear button to withdraw the licence, which is what it eventually did with BCCI,” he said. “The FSA runs more of an enforcement regime. It can fine and even prosecute. It has a whole armoury of means to obtain the results it wants.”
Since 2000, the FSA has also developed a “risk-based” strategy. Rather than devoting a disproportionate amount of resources to the routine monitoring of small, low-risk institutions, the FSA focuses on banks that either play a pivotal role in the financial system or are perceived to have potentially lax management or controls.
The FSA emphasises, however, that it is not a “zero- failure” regulator. Its goal is not to prevent financial failures entirely, because doing so would effectively regulate all risk out of the system.
International regulation has also been shaken up in the years since BCCI failed. The bank’s convoluted group structure, which included companies registered in Luxembourg and the Cayman Islands, created difficulties for regulators.
It was unclear where BCCI was controlled from, and became obvious national regulators were not sharing information or working together effectively.
The European Union’s 1992 consolidated supervision directive sought to address some of the problems.
But regulators remain in a non-stop race to keep up with changes in economic reality. Financial innovations, clever legal structures and cross-border mergers – all supported by the ethos of the free market – can present regulators with institutions that at first glance appear to defy supervision.
Get alerts on Front page when a new story is published