New era for banking as bosses quit

Joshua Rozenberg
14.10.08

Scotland's two leading banks announced yesterday that their chairmen and chief executives would be standing down as part of the Government's extraordinary bailout deal.

Can this have been what the Prime Minister meant last week when he said: "We will build on the Financial Services Authority's work to ensure that excessive risk-taking is not rewarded but punished"?

But what role is there for the FSA? As Gordon Brown pointed out, it was the board of RBS that decided Sir Fred Goodwin should no longer remain chief executive. How can a regulator ensure that people who might take excessive risks do not become leading bankers in the future? And surely the whole point of being an entrepreneur is to take risks?

The FSA already vets people who want to become directors or non-executive directors of banks, building societies, insurance companies and other regulated firms. Applicants must provide details of their employment history and answer a series of written questions to satisfy the FSA that they are "fit and proper".

Even then, approval may be withdrawn if the FSA considers that people are no longer fit to perform what are called controlled functions at an authorised firm. This happened to Chris Headdon, 51, the former chief executive of Equitable Life, who had his authorisation withdrawn for six years in 2004.

But the reason for his ban was not that Equitable had nearly collapsed in 2000. It was imposed because the former actuary had failed to disclose the existence of a "side letter" which raised questions about the true value of a reinsurance contract that Equitable had arranged with another company.

So will we see the FSA withdrawing its approval from bankers who have been sailing too close to the wind in the current crisis? "I think it's unlikely," says Ailbhe Edgar, a litigation partner at the law firm Lovells who specialises in financial services regulation. "We can all make business mistakes. But if you made your decision based on a proper analysis of the relevant information, it's difficult to say that you are no longer fit and proper because you have taken such a risk."

Edgar believes the FSA will come under pressure to hold individuals to account for the current crisis. "But the problem the FSA has always faced is the extent to which they can discipline individuals for a breach of the FSA's rules by a company. It is often difficult to lay the blame for bringing down a bank at the feet of one individual."

What about cutting executives' pay and bonuses? The FSA has no power to do this. But, as part of the bank rescue package, the Government has promised to review payments to senior executives both for 2008, when it expects no cash bonuses to be paid to board members, and for long-term incentive schemes.

In the meantime, the FSA will have to look for ways to improve its vetting procedures. How can it ensure that "excessive risk-taking is not rewarded but punished"?

First, it will need to hold face-to-face interviews with would-be bank directors. Interviewers would have to test an applicant's risk-taking attitudes in a reasonably sophisticated way: there is no point in simply asking someone to state their approach to risk on a scale of one to 10.

Edgar doubts whether any of the bank directors who are currently in such trouble would have had any difficulty with such an interview, especially if they had received some advance training."They're highly educated professional people with great experience of the industry and I am sure they would all have interviewed very well."

The FSA would probably have to bring in retired bankers to do the interviews, since FSA staff are unlikely to have the skills to cross-examine senior directors about how they would cope with an unprecedented crisis. And even then it would be difficult to judge how well an individual would stand up to pressure.

The best way of weeding out failed executives is still the traditional one shareholder pressure. What's new is that the Government is now the shareholder.