The Prudential Regulatory Authority plans to crack down on risky U.K. banks when it takes over financial regulation next year, restricting the dividends and bonuses of lenders at an earlier stage.
Lenders considered a risk to financial stability by the PRA, which will take over bank supervision by the end of 2012, will also face limits on leverage until their business stabilizes, the Financial Services Authority said in a statement today.
“This supervisory approach, to be effective, will need to be based on judgment and a forward-looking assessment of risk,” Hector Sants, who will lead the PRA and is the current chief executive officer of the FSA, said in a speech in London today.
Sants has been pledging more “intrusive” regulation since shortly after the start of the global financial crisis. The government is pushing through the biggest shakeup in financial regulation since 1997, scrapping the FSA and handing its supervisory powers to the new regulator within the Bank of England.
The plan would also create a Financial Policy Committee in the central bank to oversee economic stability risks.
“In cases where a firm’s viability is under threat, the PRA will take supervisory action at an early stage to reduce the probability of disorderly failure,” Andrew Bailey, the deputy-CEO of the PRA, said in a speech.
The new regulator will allow banks to fail and “will not view the failure of an institution in an orderly manner as regulatory failure, but rather as a feature of a properly functioning market,” the FSA said in its statement.
“Clearly the new supervisory process will look at all aspects of each bank’s operations and we feel that the specific reference to bonuses is sadly playing to politicians and the press rather than providing a greater insight into the supervision process,” a Mediobanca SpA analyst said in a note to clients.
The U.K. government provided a 45 billion-pound ($73 billion) bailout to Royal Bank of Scotland Plc in 2008 after it ran up the biggest loss in U.K. corporate history following its acquisition of ABN Amro Holding NV.
Sants said in his speech that part of the reason for the FSA’s failures was that “it never achieved the full support of Parliament and the public.” The PRA must be able to repair those relationships.
“The PRA is prepared to be judgmental and will challenge managers on fundamental aspects of their business," said Ash Saluja, a financial services lawyer at CMS Cameron McKenna LLP in London. ‘‘Unlike the FSA, the new regulator will be able to reach a different view than managers and confront them on the risk involved in their operations."
Sants said the agency needs public support.
‘‘It is vital to its reputation and authority and ultimately its ability to deliver on society’s expectation that the PRA’s powers and statutory obligations are fully understood and supported by society,’’ Sants said.
U.K. banks will also be required to publish more detailed information about their activities to encourage greater market discipline, Bailey said.
‘‘We recognize that management, shareholders, creditors and auditors all play an important role in managing prudential risk,’’ Bailey said. ‘‘To encourage more market discipline, the PRA will seek to publish some regulatory returns, though it will not go so far as to disclose its own supervisory judgments about firms.’’
Bailey last month joined the FSA as the deputy head of its Prudential Business Unit, as well as becoming director of the organization’s division overseeing U.K. lenders.
He will become the deputy head of the PRA, which is proposed to be responsible for regulating all deposit-taking institutions, insurers and investment banks.
Sants said that the PRA would scrutinize firms’ bonus payouts on an ‘‘individual and aggregate level” to make sure that banks that make large payments keep enough capital in reserve to whether crises.
The regulator would examine “total payouts to employees and make sure they aren’t putting at risk the capital position of the institution,” Sants said.