The reform scraps the 12-year-old Financial Services Authority, which took the blame for failing to head off the 2008 financial meltdown, or to prevent the mis-selling of products to customers leading to billions of pounds in compensation claims.
It has been replaced by two new bodies, a Prudential Regulation Authority (PRA) to make sure banks are sound, and a separate Financial Conduct Authority (FCA) to ensure they do not mistreat customers.
Chancellor George Osborne said: “They represent a fundamental change in how financial services will be regulated in the future.”
According to analysts, the real test of the new system will not come until boom times return, and regulators get a chance to prove they can rein in excesses.
The PRA, a subsidiary of the Bank of England, will ensure that banks, insurers and building societies hold enough capital and abide by rules to curb bonuses and monitor risk.
The FCA, which has Martin Wheatley as its chief executive, is a standalone body which will be based in the former FSA’s building in London’s Canary Wharf. It will supervise behaviour at all financial institutions, and will go after cases of misconduct with tougher powers, and higher fines.
Britain was forced to pump £65bn into Royal Bank of Scotland and Lloyds to keep them afloat during the 2007-09 financial crisis, prompting public outrage and calls for reform.
British banks have also been hit in recent years by huge settlements linked to mis-selling scandals.
The hope is that the new ‘twin peaks’ system will be able to sound the alarm on risky activities much earlier to shield taxpayers in future.
Sceptics believe that a new system would not automatically provide better supervision. Since 2007, the FSA has already ditched its discredited – and then government-sanctioned – ‘light touch’ approach to become one of the world’s toughest regulators, using its existing structure.
“If one goes back to 2008 and considers whether this would have made a real difference, that is debatable,” said Peter Snowdon, a financial services lawyer at Norton Rose.
“The new system is designed to deal with the problems that happened yesterday. No regulatory system has managed to be entirely successful in any crisis.”
The restructuring also gives the Financial Policy Committee at the Bank of England formal authority to set the direction for supervision and look out for risks to stability, such as property bubbles.
The committee is chaired by the central bank governor and includes the heads of the two new regulatory bodies.
Last week it ordered Britain’s main banks to swell their capital buffers by £25bn. The new bodies are expected to bring in a more interventionist, judgement-led style of supervision aimed at improving culture and standards. The FCA has said it will examine how much money banks make from products, to make sure customers are not being ripped off.
“The big difference from today will be that firms will place a greater focus on collaborative relationships with customers, which involves them from start to finish in financial product design,” said David Kenmir of consultancy PwC.
Some FPC members said their real test will come when the economy starts to grow rapidly, and there’s a need to call for tighter credit.