Formal rules versus informal relationships: Prudential banking supervision at the fsa before the crash

Abstract

Prior to the 2007-9 banking crisis, the UK Financial Services Authority presented itself as a 'proportionate' and 'risk-based' regulator, preferring firms to adhere to the spirit of high-level principles rather than the letter of detailed rules. Simultaneously, it developed a supervisory regime that was unprecedentedly complex, producing a 'Handbook' of intricate secondary legislation that ran to some 8000 pages. Explaining these contradictory aspects of the pre-crisis regime demands a reappraisal of the dominant explanations of the supervisory failures that contributed to the banking crisis. In contrast to accounts that focus on officials' uncritical adherence to efficient market thinking (regulatory groupthink) or the political clout of the financial industry (regulatory capture), this article suggests that supervisory officials' actions can be understood only by reference to their institutional and structural contexts. Amid heightened public sensitivity to risk, officials developed an elaborate and transparent supervisory framework as a defence against potential political censure. At the same time, collegial firm-supervisor relationships were preserved as state-of-the-art risk-management ideas were recombined and repackaged in line with the institutional legacies of earlier 'club-like' modes of supervision. Together, these divergent tendencies contributed to overconfidence in the use of predictive risk assessment and neglect of banks' fundamental business risks. © 2013 Taylor & Francis.