Bank Regulatory Structure: The United Kingdom (Chapter Report, 12/29/94,
GAO/GGD-95-38).
Proposals to consolidate U.S. banking regulatory agencies have raised
questions about how other nations structure and carry out their various
bank regulation and supervision and central bank activities. This report
provides information about such activities in the United Kingdom, which
provides an example of a bank regulatory structure dominated by its
central bank. GAO describes (1) the U.K. bank regulatory and supervisory
structure and its key participants; (2) how that structure functions,
particularly with respect to bank authorization, regulation, and
supervision; and (3) how banks are examined.
--------------------------- Indexing Terms -----------------------------
REPORTNUM: GGD-95-38
TITLE: Bank Regulatory Structure: The United Kingdom
DATE: 12/29/94
SUBJECT: Banking regulation
Foreign governments
Financial institutions
International economic relations
Bank management
Bank deposits
Capital
Banking law
Bank examination
Deposit funds
IDENTIFIER: United Kingdom
European Union
European Community Single Internal Market Program
Deposit Protection Fund
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Cover
================================================================ COVER
Report to the Honorable
Charles E. Schumer
House of Representatives
December 1994
BANK REGULATORY STRUCTURE - THE
UNITED KINGDOM
GAO/GGD-95-38
U.K. Bank Regulatory Structure
(233433)
Abbreviations
=============================================================== ABBREV
APACS - Association for Payment Clearing Service
APB - Auditing Practices Board
BCCI - Bank of Credit and Commerce International
DTI - Department of Trade and Industry
ECU - European Currency Unit
EEA - European Economic Area
EFTA - European Free Trade Area
EU - European Union
JMB - Johnson Matthey Bankers
SIB - Securities and Investments Board
SIU - special investigations unit
SRO - self-regulatory organization
Letter
=============================================================== LETTER
B-259284
December 29, 1994
The Honorable Charles E. Schumer
House of Representatives
Dear Mr. Schumer:
Proposals to consolidate United States bank regulatory agencies have
raised questions about how other countries structure and carry out
their various bank regulation and central bank activities. You asked
us to provide you with information about the structure and operations
of regulatory activities in the Federal Republic of Germany, United
Kingdom, Canada, and France. This report presents the information
you requested for the United Kingdom. It describes the U.K. bank
regulatory structure, how that structure functions, and how banks are
examined.
As agreed with your office, unless you publicly announce its contents
earlier, we plan no further distribution of this report until 30 days
from the date of this letter. At that time, we will send copies of
this report to members of the House Committee on Banking, Housing and
Urban Affairs; other congressional committees; and other interested
parties. We will also make copies available to others on request.
The report was prepared under the direction of Mark J. Gillen,
Assistant Director, Financial Institutions and Markets Issues. If
you have any questions, please call me on (202) 512-8676. Other
major contributors are listed in appendix IV.
Sincerely yours,
James L. Bothwell
Director, Financial Institutions
and Markets Issues
EXECUTIVE SUMMARY
============================================================ Chapter 0
PURPOSE
---------------------------------------------------------- Chapter 0:1
Proposals to consolidate U.S. banking regulatory agencies have
raised questions about how other countries structure and carry out
their various bank regulation and supervision and central bank
activities. Representative Charles E. Schumer asked GAO to provide
information about the structure and operations of such activities in
the Federal Republic of Germany,\1 the United Kingdom (U.K.), Canada,
and France. This report presents the information requested for the
United Kingdom, which provides an example of a bank regulatory
structure dominated by its central bank. Our objectives were to
describe (1) the U.K. bank regulatory and supervisory structure and
its key participants; (2) how that structure functions, particularly
with respect to bank authorization, regulation, and supervision; and
(3) how banks are examined. This report provides requested
information about the U.K. bank regulatory structure, but does not
include a GAO evaluation of that structure.
--------------------
\1 For information on the German bank regulatory and supervisory
structure, see Bank Regulatory Structure: The Federal Republic of
Germany (GAO/GGD-94-134BR, May 9, 1994).
BACKGROUND
---------------------------------------------------------- Chapter 0:2
The banking structure in the United Kingdom is relatively
concentrated and, as a result of London's position as a major
financial center, includes many foreign banks. As of February 28,
1994, 8 of the 518 banks in the United Kingdom held approximately 50
percent of the country's �1.2 trillion ($1.9 trillion)\2 banking
assets. More than half of the total banks, 286, were incorporated
outside the United Kingdom, including 129 banks from member countries
of the European Economic Area. Any bank in the United Kingdom may in
effect conduct a universal banking business, including securities and
insurance activities.
Bank regulation and supervision was first recognized in statute as a
government function in the United Kingdom in the Banking Act of 1979
(1979 Act) in which supervisory and regulatory responsibilities,
including the authorization of banks, were vested in the Bank of
England (the Bank), the U.K. central bank. Nevertheless, the
Bank--a private institution until it was nationalized under the Bank
of England Act of 1946--had acted as informal bank supervisor long
before then. The Bank's influence resulted primarily from its market
power and respect from other market participants and was dependent on
mutual trust and cooperation.
Bank supervision has gradually become more formal in nature, both as
a result of changes in financial markets and as a consequence of
three banking crises that prompted changes in law and supervision.
For example, the 1979 Act was passed (1) largely in response to the
failure of several smaller banks in the United Kingdom, which exposed
weaknesses in bank supervision, and (2) in order to implement the
1977 European Community First Banking Directive--a first step in the
creation of a single European financial market. In addition to
establishing an explicit bank regulatory and supervisory structure,
the 1979 Act created a deposit protection system.
The Banking Act of 1987 (1987 Act) expanded the formal
responsibilities of the Bank. It was passed largely because of the
failure of a major participant in London's gold bullion market. The
1987 Act gave bank external auditors a legal responsibility to
provide information to the Bank when requested to do so. This was
seen as the most efficient way of introducing the necessary checks on
bank systems and controls while drawing on an existing pool of
expertise. In addition, the 1987 Act established a Board of Banking
Supervision within the Bank. The Board's purpose was to advise the
Bank on its supervisory and regulatory duties under the 1987 Act.
In 1991, the failure of the Bank of Credit and Commerce International
led to changes in the 1987 Act and to the organization of bank
supervision in the Bank that was intended to strengthen bank
supervision. These changes notwithstanding, the Bank has retained
most of its discretion in taking supervisory action.
The Bank is formally governed by its 16-member Court of Directors,
but it is managed by the Governor of the Bank, his Deputy, and four
executive directors responsible for monetary and financial stability.
The Bank is subordinate to Her Majesty's Treasury (the Treasury) and
accountable to Parliament, but is accorded a high degree of
independence with respect to bank regulation and supervision. It has
a bank supervisory staff of 249, including 57 support staff. (See
app. I.)
--------------------
\2 We used the November 10, 1994, exchange rate of $1.60.
RESULTS IN BRIEF
---------------------------------------------------------- Chapter 0:3
Since the passage of the 1979 Act, the Bank has been formally
recognized in statute as the primary regulator and sole supervisor of
authorized banks in the United Kingdom. Its primary purpose in bank
supervision is to protect the interests of depositors. Its
responsibilities include authorizing banks to take deposits;
developing and issuing bank regulations; taking both formal and
informal enforcement actions against banks--including the restriction
and revocation of a bank's authorization; and taking action when bank
liquidity or solvency problems arise.
The Bank also has the authority to examine and request information
from banks and to require accounting firms to produce
reports--including annual reports on bank records and controls. The
Bank, however, does not conduct full-scope, on-site examinations of
authorized banks, nor does any other entity. Instead, on-site
information of banks comes from limited bank reviews carried out by
an 11-member Bank review team and annual and special reports required
of banks' reporting accountants.
The Board of Banking Supervision is an independent committee that
advises the Bank on its actions. The Board is generally viewed as a
valuable component of banking supervision. Its involvement with the
Bank's Surveillance and Supervision area, which carries out bank
supervisory activities, has recently been strengthened.
In addition to its role in bank regulatory and supervisory matters,
the Bank has responsibilities in other bank-related activities, such
as liquidity provision, crisis management, payments settlement,
international negotiations, and lender of last resort. Furthermore,
the Bank's Governor heads the Deposit Protection Board, and the Bank
provides staff to the deposit protection system, although the Deposit
Protection Fund is privately funded through levies on authorized
banks with no direct financial backing from the Bank or U.K.
taxpayers.
Figure 1: Responsibility for
Bank Regulatory and Related
Functions in the United Kingdom
(See figure in printed
edition.)
Source: GAO analysis.
PRINCIPAL FINDINGS
---------------------------------------------------------- Chapter 0:4
THE BANK HAS SOLE
RESPONSIBILITY OVER BANK
AUTHORIZATION AND
SUPERVISION
-------------------------------------------------------- Chapter 0:4.1
The 1987 Act gives the Bank sole authority to authorize banks to take
deposits, but stipulates that banks first meet six minimum criteria.
These criteria are related to capital; liquidity and other measures
of prudent conduct; and the number, integrity, and ability of bank
managers.
The Bank is also solely responsible for taking enforcement actions
against banks "to ensure compliance with . . . standards and to
protect depositors and potential depositors." Many of the supervisory
actions taken by the Bank are informal. In such cases, the Bank will
"recommend" that certain actions be taken by a bank to remedy
identified problems. Formal actions--such as revoking a bank's
authorization, taking action against a bank in order to remove bank
managers or directors, or imposing conditions on a bank--are taken
relatively infrequently. According to the Bank, informal action is
normally the first choice because it is easier to put into effect and
provides more flexibility to ensure that corrective action is taken
by the bank. Furthermore, informal recommendations are effective
because of the well recognized and broad discretionary authority the
Bank has to use its formal enforcement powers.
THE BANK HAS PRIMARY
RESPONSIBILITY OVER
REGULATION
-------------------------------------------------------- Chapter 0:4.2
The Bank has primary responsibility for implementing the 1987 Act, to
clarify provisions in law, and to provide guidance on the Bank's
interpretations of requirements in the act. It has done so by
issuing (1) its Statements of Principles, supervisory notices, and
guidance notes, which have the force of law; (2) recommendations on
certain issues, with which banks are expected to make every effort to
comply; and (3) interpretive letters on its policies in response to
questions from individual banks. The Treasury, headed by the
Chancellor of the Exchequer, on the other hand, is solely responsible
for developing legislation, although it does receive advice from the
bank. The 1987 Act also provides that the Treasury may issue
regulations in some instances.
THE BANK RELIES ON MANY
SOURCES OF INFORMATION TO
CARRY OUT ITS SUPERVISORY
RESPONSIBILITIES
-------------------------------------------------------- Chapter 0:4.3
To carry out its supervisory responsibilities, the Bank relies on
several sources of information including banks, financial markets,
and chartered accountants. The sources of information upon which
bank supervisors place primary reliance are the numerous reports
banks are required to submit to the Bank, over 3,000 formal meetings
in a recent 1-year period, and other informal contacts with the
banks.
In addition, Bank supervisors are provided with on-site information
collected by Bank review teams and chartered accountants. This
information, together with that collected directly from banks, is
intended to give supervisors a complete picture of the banks for
supervisory purposes.
The Bank's own review teams are small, and their reports tend to be
qualitative, focusing on quality of management, since visits are
short and much of the teams' information is derived from interviews.
U.K. chartered accountants, therefore, perform a meaningful part of
the on-site information gathering function through (1) annual bank
systems and records reviews, (2) special reviews under the 1987 Act,
and (3) financial audits mandated under corporate law. These reviews
and audits are conducted under guidelines issued by the Bank and
standards issued by the industry's standard-setting body. Chartered
accountants were assigned their Banking Act responsibilities not only
because they had expertise in banking, but also because the Bank
preferred its traditional, nonintrusive approach to supervision,
which it believes has served it well. With the exception of certain
special reviews, the reviews and audits are done by accounting firms
of the banks' choice and at the banks' expense. However, a bank's
appointment of an accountant to conduct reviews under the Banking Act
may be disapproved by the Bank. Chartered accountants are subject to
unlimited liability whether performing reviews under banking or
corporate audits law.
THE BANK HAS SEVERAL OTHER
BANK-RELATED
RESPONSIBILITIES
-------------------------------------------------------- Chapter 0:4.4
The Bank also has several other bank-related responsibilities.
-- The Governor of the Bank heads the Deposit Protection Board,
which administers the deposit protection system and controls the
Fund that pays out claims. Three other members of the Board are
Bank officials, while three are representatives of member banks.
The Bank, however, has no responsibility for funding the Deposit
Protection Fund whose resources are provided by the banking
industry.
-- The Bank provides day-to-day liquidity to the banking system and
acts as lender of last resort.
-- The Bank plays the lead role in crisis management involving
financial institutions, both as a result of its role as lead
regulator of banks and as a major participant in financial
markets.
-- The Bank is the settlement institution for members of the
payment systems and is a member of several organizations that
operate payment systems. It does not, however, own or operate
any of these systems.
-- The Bank represents the United Kingdom in several international
organizations, most notably the Bank of International
Settlements, and the Basle Committee of Banking Supervisors.
RECOMMENDATIONS
---------------------------------------------------------- Chapter 0:5
This report contains no recommendations.
AGENCY COMMENTS
---------------------------------------------------------- Chapter 0:6
Senior officials from the Bank of England, the Building Societies
Commission, the British Bankers Association, and several accounting
firms reviewed and commented on a draft of this report. These
comments were generally technical in nature and were incorporated
where appropriate.
INTRODUCTION
============================================================ Chapter 1
The history of bank regulation and supervision in the United Kingdom
(U.K.) reflects the relatively concentrated nature of the banking
industry as well as British reliance on common law.\1
The conduct of bank regulation and supervision in the United Kingdom
has evolved significantly since the Bank of England (the Bank), was
given statutory responsibility for bank regulation and supervision in
1979. This evolution has largely been in response to a series of
banking crises that reflected the changing nature and increasing
complexity of banking in the United Kingdom.
--------------------
\1 The term "regulation" in this report is used to mean the enactment
of rules by which U.K. banks must abide. The Bank has noted that it
regards its responsibilities as primarily supervisory, not
regulatory, since U.K.-authorized institutions' powers are not
restrictive--as long as they meet the Bank's minimum criteria. In
the context of this report, nevertheless, such minimum criteria as
well as supervisory notices and guidance notes issued by the Bank,
which have the force of law, are considered regulations. (See ch. 2
for further discussion of the Bank's supervisory and regulatory
responsibilities.)
OVERVIEW OF U.K. BANKING
INDUSTRY
---------------------------------------------------------- Chapter 1:1
As of February 28, 1994, there were 518 banks operating in the United
Kingdom with total assets of approximately �1.2 trillion (see table
1.1).\2 Approximately half of these assets--�593 billion--were held
by eight of the larger British banks.\3
Table 1.1
The United Kingdom Authorized\a Bank
Population (1987-1994)
End-February 1987 1988 1989 1990 1991 1992 1993 1994
-------------------------------- ---- ---- ---- ---- ---- ---- ---- ----
U.K.-incorporated 334 313 295 289 275 263 253 232
Incorporated outside the U.K. 254 254 256 259 255 255 255 286
================================================================================
Total 588 567 551 548 530 518 508 518
--------------------------------------------------------------------------------
\a A financial institution that has been approved to conduct banking
activities by its home country bank supervisor.
Source: The Bank of England, Banking Act report for 1993/94.
More than half of the banks in the United Kingdom, 286, were
incorporated outside the United Kingdom. Of those banks, 129 were
European-authorized institutions\4 --banks licensed in the European
Union (EU)\5 or European Free Trade Area (EFTA) member nations who
have chosen to participate in the European Economic Area (EEA).\6
Any authorized bank in the United Kingdom--including subsidiaries of
foreign-owned banks--may conduct securities and insurance activities,
as long as the latter are carried out in bank subsidiaries.\7 This,
in effect, permits banks to conduct a universal banking business. In
principle, insurance and securities firms may also own banks--as may
commercial firms--provided that they are considered to be "fit and
proper" owners by the bank's supervisor. In practice, however, such
ownership arrangements are not widespread.
Another major class of deposit-taking financial institutions in the
United Kingdom is building societies. They are mutual deposit-taking
institutions owned by the depositors of the institutions, which lend
predominantly for house purchases. Only 25 percent of their assets
may be in commercial or unsecured lending. As of March 31, 1993,
there were 87 building societies authorized to take deposits of which
the top 10 held 90 percent of the industry's assets. Building
societies are supervised by the Building Societies Commission, rather
than by the Bank (see app. III for additional details).
--------------------
\2 On October 14, 1994, the British pound was worth $1.59.
\3 The banks that make up the eight larger U.K. banks as defined by
the Bank, are Barclays, Lloyds, Midland, National Westminster--the
four clearing banks--and the Bank of Scotland, The Royal Bank of
Scotland, Standard Chartered, and the TSB Bank. In fact, they are
not the eight largest banks in the United Kingdom since technically
that number would include a former building society now converted to
a bank.
\4 Ninety-seven of these were authorized to take deposits in the
United Kingdom.
\5 Members of the EU are: Belgium, Denmark, France, Germany, Greece,
Ireland, Italy, Luxembourg, the Netherlands, Portugal, Spain, and the
United Kingdom.
\6 The EEA came into being on January 1, 1994, and extends the EU
single-market concept, covering the free movement of goods, services,
capital, and people, as well as other rules to the EEA. The EEA
includes the 12 EU member states and the 5 EFTA states participating
in the EEA: Austria, Finland, Iceland, Norway, and Sweden.
A bank incorporated in any EEA country is free to branch elsewhere in
the EEA, subject to satisfying its home supervisor that it is
qualified to do so. This authority was provided under the EU's
Second Banking Coordination Directive and is often referred to as the
banking "passport." The host supervisor has no power to veto branches
from EEA member banks.
\7 Branches of banks chartered in countries that are members of the
EU may not conduct insurance activities in the United Kingdom until
an EU directive on insurance activities is agreed to.
HISTORY OF BANK REGULATION AND
SUPERVISION IN THE UNITED
KINGDOM
---------------------------------------------------------- Chapter 1:2
Bank regulation and supervision was first recognized in statute as a
government function in the Banking Act of 1979 (1979 Act) in which
supervisory and regulatory responsibilities were vested in the Bank
of England, the U.K. central bank. Banks in the United Kingdom are
regulated and supervised almost exclusively to ensure the safety and
soundness of individual banks and of the system as a whole. For
example, U.K. banking laws do not address issues such as fair
lending practices or community reinvestment requirements.\8
Until that time, no government agency had either formal powers to
grant or refuse authorization to conduct banking business in the
United Kingdom or any statutory supervisory role. Nonetheless, the
longstanding position of the Bank as arguably the most influential
financial institution in the United Kingdom\9
resulted in its assuming an informal supervisory role as early as the
mid-nineteenth century.
As a result of its primary role in the financial markets, the Bank
was concerned about the creditworthiness of its counterparties--a
relatively concentrated number of larger banks with whom it did
business. It was also concerned about the prevention of market
disruption, which could result from the failure of a market
participant. Because of these concerns, the Bank assumed some
informal supervisory responsibilities for these banks that involved
(1) undertaking surveillance;\10 (2) advising banks to take certain
steps to resolve perceived problems; and (3) providing short-term
financial support when needed. These actions on the part of the Bank
were informal and nonstatutory and were based solely on the Bank's
influence in the markets and the willingness of other banks to accept
this supervision to further their business interests.
The Bank of England Act of 1946, which nationalized the Bank by
giving ownership of the Bank to Her Majesty's Treasury (the
Treasury), did not clarify or significantly bolster the Bank's
informal supervisory role. It gave the Bank the power to "request
information," "make recommendations" to bankers, or "issue
directions" to bankers with the Treasury's consent, but of these none
was considered to be a supervisory power, and the Bank never made use
of its authority to issue directions. However, the act did not
prohibit the Bank from continuing in its informal supervisory role,
thus implicitly acknowledging the Bank's status as the principal
supervisory force. This informality of bank regulation is consistent
with British reliance on common law and a common understanding of
government authority and its limits.
Thus, the Bank was able to continue exercising strong influence over
the group of discount houses\11 and accepting houses\12 with which it
did business. Its informal supervision was based on cooperation and
trust and carried out via requests rather than directives. The
Bank's influence resulted from its role as the arm of the government
in the city (i.e. London financial center), its power in the market,
and respect from other market participants, and it was dependent on
mutual trust and cooperation. However, it was harder for the Bank to
achieve this trust and cooperation with newer and foreign-owned banks
that were established in the 1960s and 1970s.
The 1946 Act clearly establishes the subordination of the Bank to the
Chancellor of the Exchequer who heads the Treasury, as well as the
Bank's accountability to Parliament through the Treasury. For
example, under the act, the Chancellor has the power to issue
directions to the Bank after consultation with the Governor of the
Bank, a provision that was designed to ensure that, in the event of
disagreement, the government would have the final say. However, the
Chancellor has never used this power, since policy has been actively
coordinated between the Treasury and the Bank--the Chancellor and the
Governor of the Bank meet at least twice a month, according to Bank
officials--and the Bank has openly acknowledged the Treasury's
policymaking preeminence.
The Treasury has no formal role under the Banking Act in banking
supervision, although it would expect to be consulted on any major
regulatory or supervisory decision, particularly when there are
political, economic, or legislative implications or public
expenditure consequences. Furthermore, although the Treasury
generally defers to the Bank in such matters, it is not required to
do so, and a future change in Treasury policy toward the Bank under a
different government cannot be ruled out.
The bank regulatory and supervisory role of the Bank was not codified
until the so-called "secondary banking crisis" of 1973 through
1974\13 exposed weaknesses in the supervisory system. The crisis
revealed that many smaller banks--called secondary banks--were
outside even the informal surveillance of the Bank. The 1979 Act
that evolved from this crisis, as well as the requirement to
implement the First Banking Directive passed by the European Economic
Community (now the European Union) in 1977, recognized the need for a
more formal framework for the supervision of all banks. The 1979 Act
(1) codified the Bank's existing informal supervisory
relationships,\14 (2) brought all banks under the Bank's supervision,
(3) required banks and deposit-taking institutions to meet certain
criteria, (4) enacted a deposit protection system, and (5) was
explicitly designed to provide a degree of protection for bank
depositors.
Another banking crisis occurred in 1984, when Johnson Matthey Bankers
(JMB) was rescued by the Bank and a group of other banks.\15
According to a 1992 report to Parliament,\16 bank management had
suffered lapses that had not been recognized or addressed by Bank
supervisors: controls and systems had been inadequate, the
monitoring of credit had been defective, insufficient attention had
been given to concentrations of risk, proper security measures had
not been taken, and provisions for bad and doubtful debts had not
been assessed with appropriate care. Concerns about the role
inadequate bank supervision had played in this crisis led to a review
of the system of bank supervision, which resulted in the passage of
the Banking Act of 1987 (1987 Act).
The deregulation of financial markets in the United Kingdom in
October 1986, commonly known as the "Big Bang," was another financial
market milestone in the United Kingdom, as was the relaxation or
abolition of exchange controls, mortgage lending guidance, and
consumer credit controls. The Big Bang eliminated fixed commissions
on stock and bond purchases; removed the separation among the
underwriting, sales, and trading functions; and allowed foreign firms
to buy U.K. securities firms. The heightened competition that
followed resulted in a focus on capturing market share. Although
securities firms were primarily affected, banks were also involved in
the competitive shakeout that followed the Big Bang.
The 1987 Act confirmed the role of the Bank as supervisor, expanded
its formal responsibilities, and eliminated the distinction between
banks and nonbank deposit-taking institutions. Among other things,
the act (1) revised the minimum criteria for authorizing a bank; (2)
established an advisory board, the Board of Banking Supervision, to
advise the Bank on its actions; (3) amended the grounds on which the
Bank might or was required to revoke authorization; (4) gave the Bank
the power to restrict an authorization and set up an appeals process;
(5) required banks to report their large exposures to the Bank; and
(6) enhanced the Bank's authority to obtain information from a bank.
These supervisory responsibilities are discussed in greater detail in
chapter 3.
In addition, the act gave bank accountants and auditors\17 a legal
responsibility to provide information to the Bank when requested to
do so. In conjunction, the act relaxed the ordinary duty of
confidentiality owed by an auditor or accountant to its client in
certain circumstances.
Further, the fraud uncovered in the Bank of Credit and Commerce
International (BCCI) and its closure in 1991, led to additional
concerns about bank supervision in the United Kingdom and questions
about the Bank's continuing role in bank supervision. To date, major
changes in the structure of bank supervision have not been made as a
result of these concerns; however, changes have been made in the
legislation and organization of bank supervision in the Bank. These
changes were intended to improve the information available to the
Bank, encourage a more proactive philosophy on the part of the Bank,
and strengthen bank supervision in general. These changes included
(1) establishing new Special Investigations and Legal units; (2)
strengthening the involvement of the Board of Banking Supervision;
(3) more intensely training supervisors in issues of fraud; (4)
improving communication within the Bank, and between the Bank, the
Treasury, and other government departments; and (5) requiring bank
accountants and auditors to report material breaches of the
authorization criteria by the banks they audit to the Bank.
Overlaying these events has been the development of a unified
financial services market in the EU, which has also affected U.K.
bank regulation and supervision. Central to the liberalization of
financial services under the Single Market Program is the concept of
a "single passport." Once a financial firm is established and
licensed in one member state, its home country, that firm can use a
single passport to offer financial services in any other member
state, or host country. Underlying the Single Market Program is an
understanding that a minimum level of harmonization in regulation is
necessary among the member countries to ensure the safety and
soundness of the financial system. For instance, the EU Second
Banking Directive requires all EU banks to have a minimum capital
base and a minimum level of shareholder disclosure and limits equity
participation in nonfinancial firms. Consequently, all EU member
countries, including the United Kingdom, have had to change their
banking laws and regulations as necessary to meet the minimum
requirements imposed by EU financial services directives. To date,
however, the structure of bank regulation in the United Kingdom has
not been changed as a result of EU directives.\18
--------------------
\8 The banking industry has addressed some of these issues in a
voluntary Code of Banking Practices, which first came into force in
March 1992.
\9 The Bank was established in 1694 as a privately owned bank. By
1844, it was the sole issuer of bank notes in England, the manager of
the government debt, and the central participant in the market for
discounting bills.
\10 For example, the Bank's Discount Office required financial
information from other banks.
\11 Discount houses are counterparties of the Bank in its operations
in the pound sterling money market.
\12 The original purpose of accepting houses was the financing of
trade, and they provided a large proportion of the acceptance
facilities available in the U.K. banking system. Now accepting
houses also specialize in corporate finance activities, stockbroking,
investment management, term lending, and syndications.
\13 During the secondary bank crisis, several secondary banks in
Britain developed serious financial difficulties that were feared to
pose a threat to the financial system as a whole. The Bank organized
a rescue of these banks to stave off systemic problems.
\14 The 1979 Act made a distinction between banks, which the Bank was
empowered to recognize, and other deposit-taking institutions, which
the Bank was empowered to license. The major functional difference
between the two was that the Bank could only recognize a bank if it
was satisfied that the bank provided or would provide either a wide
range of banking services--such as checking accounts, foreign
exchange, commercial loans--or a highly specialized banking service.
A licensed deposit-taking institution did not have to meet this
requirement.
\15 JMB was one of the five London gold price fixers. When its
failure became imminent as a result of large loans that were in
default, the Bank feared for London's position as the leading
international gold bullion market and more widely for the confidence
in the U.K. banking system. Therefore, the Bank stepped in to
provide support for JMB.
\16 The 1992 report was entitled Return to an Address of the
Honorable the House of Commons, dated 22 October 1992, for the
Inquiry into the Supervision of The Bank of Credit and Commerce
International. Chairman: The Right Honorable Lord Justice Bingham.
This report is commonly referred to as the Bingham Report.
\17 In this report, the term "reporting accountant" or "accountant"
is used when describing accounting professionals conducting work
under the 1987 Act. The term "external auditor" or "auditor" is used
when describing accounting professionals conducting audit work under
corporate law. As described in greater detail in chapter 3, the
reporting accountant and external auditor for a particular bank are
often the same accounting firm.
\18 For additional information about the single market program, see
European Community: U.S. Financial Services' Competitiveness Under
the Single Market Program (GAO/NSIAD-90-99, May 21, 1990).
REGULATION OF BANKS' NONBANK
ACTIVITIES
-------------------------------------------------------- Chapter 1:2.1
In the United Kingdom, securities activities are conducted either in
bank subsidiaries or within the bank itself. When securities
activities are conducted in subsidiaries, the securities regulator,
the Securities and Investments Board (SIB), is responsible for
regulating the securities subsidiary.\19
Insurance activities are not permitted within a bank but are
restricted to banks' subsidiaries, and the insurance regulator, the
Department of Trade and Industry (DTI), regulates these
subsidiaries.\20
Regulators in the United Kingdom operate under the functional
regulation approach. Thus, when a bank owns nonbank subsidiaries,
the Bank remains the lead regulator and retains responsibility for
monitoring the capital levels of the banking entity as a whole, even
though the nonbank subsidiaries may be regulated by the SIB or DTI.
Similarly, if the major or top level entity is a securities firm
owning a bank, then SIB is the lead regulator of the entire entity
while the Bank regulates the bank subsidiary.
--------------------
\19 In turn, SIB recognizes self-regulatory organizations (SRO),
which carry out the regulation for almost all securities firms. The
Securities and Futures Authority is the SRO that regulates most
securities firms.
\20 While the Banking Act places no restrictions on what banks may
do, insurance legislation requires that insurance be carried out in a
separately incorporated company.
OVERVIEW OF PARTICIPANTS IN
U.K. BANK REGULATION,
SUPERVISION AND EXAMINATION
---------------------------------------------------------- Chapter 1:3
While the Bank of England is the sole bank regulator and supervisor
in the United Kingdom, it receives advice from the Board of Banking
Supervision and information from bank accountants and auditors to
help it conduct its supervisory work, as described further in
chapters 2 and 3.
BANK OF ENGLAND
-------------------------------------------------------- Chapter 1:3.1
The Bank of England was nationalized under the 1946 Act, which
provided for the transfer of ownership of the Bank's stock to the
Treasury, headed by the Chancellor of the Exchequer. According to
the Bank's annual report, "its core purposes are to maintain the
value of the currency and the integrity of the financial system, and
to promote the efficiency of financial markets."
The 1946 Act grants the Bank budgetary independence but requires it
to submit an annual report on its Banking Act responsibilities to the
Chancellor who then submits the report to Parliament. Approximately
half of the Bank's annual profit--�120 million in 1993--is paid to
the Treasury each year.
The Bank is formally governed by its Court of Directors, which
consists of the Governor, Deputy Governor, and sixteen directors, of
whom four are employed full time by the Bank and called executive
directors. One of these executive directors is responsible for bank
supervisory responsibilities within the Bank as well as payment,
settlement, and clearing systems.\21 The 12 nonexecutive directors
are drawn from banking, industry, and other areas such as accounting
firms. The Court meets weekly and serves primarily as a sounding
board for the Governor. In practice, the Bank is managed by the
Governor, with the assistance of the Deputy Governor and the four
executive directors.
All members of the Court of Directors are appointed by the Crown,
which in effect means they are appointed by the Prime Minister acting
on the advice of the Chancellor of the Exchequer after consultation
with the Governor of the Bank. All are appointed for renewable
terms: 5 years in the case of the Governor and Deputy Governor,
4-year staggered terms for the directors. Directors of the Bank may
be dismissed by the Crown, but such an event has never occurred.
The Bank carries out the supervision of banks in its Supervision and
Surveillance area formerly known as the Banking Supervision Division.
Supervision and Surveillance falls under the responsibility of one of
the executive directors on the Court of Directors, and is headed by
the Deputy Director of the Bank. It consists of five divisions: (1)
supervisory policy and statistical reporting, (2) U.K. retail and
merchant banks, (3) medium and smaller U.K. banks and enforcement,
(4) industrial world division, and (5) developing world division.
The latter two divisions include surveillance staff with expertise on
the institutional and economic backgrounds of groups of countries, in
addition to banking supervisors, who are able to draw on this
expertise.
As of the end of February 1994, the Bank had 3,905 full-time staff,
of whom 249 were Banking Supervision Division staff, including 57
support staff. The Supervision and Surveillance staff are located in
London, the head office of the Bank and the headquarters of most of
the United Kingdom's largest banks.\22
--------------------
\21 Two of these executive directors are responsible for monetary
stability, while the fourth has responsibilities for the United
Kingdom's financial infrastructure. See appendix I for additional
information on the structure and monetary policy responsibilities of
the Bank.
\22 While the Bank has nine branches and agencies located throughout
the United Kingdom, these are not used for bank supervisory purposes,
but primarily as currency distribution points and points of contact
with local industry. They also include the Bank's Printing Works and
its Registrar's Department.
BOARD OF BANKING SUPERVISION
-------------------------------------------------------- Chapter 1:3.2
The Board of Banking Supervision was established under the 1987 Act
to advise the Bank on its Banking Act responsibilities. Although
officially established by the act, the Board had been operating since
1986. It is structurally separate from Supervision and Surveillance
and advises the Bank's Court of Directors.
The Board's nine members include the Bank's Governor, Deputy
Governor, and the executive director responsible for bank
supervision, all in an ex-officio capacity.\23 The Board's six
independent members from the banking, accounting, and legal
professions are jointly appointed to 5-year terms by the Governor of
the Bank and the Chancellor of the Exchequer. (See ch. 2 for
additional information on the Board's role.)
--------------------
\23 By virtue or because of their offices.
ACCOUNTING FIRMS
-------------------------------------------------------- Chapter 1:3.3
As described further in chapter 3, reporting accountants and external
auditors provide substantial supervisory information to the Bank of
England. Although there are hundreds of external accounting firms in
the United Kingdom, about 80 percent of bank audits, including those
of the largest banks in the United Kingdom, are conducted by the "big
six" accounting firms, primarily because they have the necessary
resources to do the required work.\24 Banks audited by smaller
accounting firms tend to be the smaller banks in the United Kingdom.
--------------------
\24 These firms are known in the United States as Ernst & Young,
Arthur Andersen & Company, Deloitte & Touche, KPMG Peat Marwick,
Coopers & Lybrand, and Price Waterhouse.
OBJECTIVES, SCOPE, AND
METHODOLOGY
---------------------------------------------------------- Chapter 1:4
At the request of Congressman Charles E. Schumer, we examined
various aspects of the U.K. bank regulatory system. Specifically,
our objectives were to describe (1) the U.K. bank regulatory
structure and its key participants, (2) how that structure functions,
and (3) how banks are examined. We completed a similar study on the
bank regulatory structure in the Federal Republic of Germany\25 and
are currently undertaking studies of the systems in France and
Canada.
To address these objectives we conducted our interviews with the
Deputy Director, Supervision and Surveillance, and four other
officials of the Bank and the Deposit Protection Board. They also
provided us with various documents and statistics including copies of
reports that banks submit to the Bank, annual Bank of England reports
and accounts, and Banking Act reports; annual reports of the Deposit
Protection Board; guidance notes on relevant issues, including the
role of external auditors and reporting accountants; and statistics
on the banking industry.
In addition to our interviews with the Bank, we met with several
senior executives at U.K. banks; senior executives from accounting
firms and individuals from the Auditing Practices Board, the auditing
standards setting body in the United Kingdom, who provided us with
bank-related auditing standards, auditing guidelines, and guidance
notes. We also met with individuals from the British Bankers
Association--the organization representing banks operating in the
United Kingdom, including foreign banks--who provided us with copies
of related reports and legislation; and with an official from the
Building Societies Commission, the regulator of U.K. Building
Societies.
Finally, we reviewed the 1987 Act, the law that relates most directly
to bank regulation and supervision, and related documents including
the Bank of England's Statements of Principles. This review does not
constitute a formal legal opinion on the requirements of the law,
however.
We conducted our review from May 1994 through August 1994 in
accordance with generally accepted government auditing standards.
Senior supervisory officials of the Bank of England, the Building
Societies Commission, the British Bankers Association, and several
chartered accounting firms reviewed and commented on a draft of this
report. These comments were generally technical in nature, and were
incorporated where appropriate.
--------------------
\25 Bank Regulatory Structure: The Federal Republic of Germany
(GAO/GGD-94-134BR, May 9, 1994.)
THE BANK OF ENGLAND AUTHORIZES,
REGULATES, AND SUPERVISES BANKS
============================================================ Chapter 2
Since the passage of the 1979 Act, the Bank has been formally
recognized in statute as the primary regulator and sole supervisor of
authorized banks in the United Kingdom. The Bank's powers include
the responsibility to authorize banks to take deposits, the power to
issue banking regulations, the power to take enforcement actions
against banks--such as restricting and revoking a bank's
authorization--the right to request and receive information from
banks and accounting firms, and the right to examine banks. The
Board of Banking Supervision advises the Bank on its actions under
the Banking Act. (See ch. 3 for more information on accounting and
audit reports and bank reviews.)
AUTHORIZATION AND MINIMUM
CRITERIA
---------------------------------------------------------- Chapter 2:1
The 1987 Act gives the Bank sole authority to authorize banks to
conduct a deposit-taking business, but stipulates that banks must
meet the following six minimum criteria as set out in Schedule 3 to
the Act. These minimum criteria state that
(1)directors, controllers, or managers of institutions be fit and
proper to hold their particular positions ("fit and proper persons");
(2)at least two individuals effectively direct the business
("four-eyes" principle);
(3)for U.K. incorporated institutions, there are as many
nonexecutive directors as the circumstances and scale of operations
of the business require (nonexecutive directors);
(4)the business be conducted in a prudent manner, maintain capital of
such nature and amount as are considered appropriate, maintain
adequate liquidity and loan loss provisions, and have adequate
accounting and other records (prudent conduct of business);
(5)the business be carried on with integrity and professional skills
appropriate to the scale and nature of its activities (integrity and
skill); and
(6)the business hold at time of granting of authorization minimum net
assets of �1 million (minimum net assets).\1
In determining whether to authorize a bank, the Bank, according to
written Bank policy, also considers "if it is likely to receive
adequate flows of information from the institution and relevant
connected parties in order to monitor the fulfillment of the criteria
and to identify and assess any threats to the interests of depositors
and potential depositors." Furthermore, it "will take account of any
factors which might inhibit effective supervision, including in
particular whether the structure and geographical spread of the bank,
the group to which it may belong, and other connected companies might
hinder the provision of adequate and reliable flows of information to
the supervisors." Finally, the Bank will consider whether the bank's
companies share a common external auditor, which would simplify the
Bank's "ability to assess a banking institution's exposure to risks
elsewhere in the same group." Since the failure of BCCI, the Bank has
given the preference for a common auditor a higher profile, and
banking institutions without a common auditor have become
increasingly rare.
--------------------
\1 Bank of England, Statements of Principles, (May 1993), and The
Bank of England's Relationship With Auditors and Reporting
Accountants, (Mar. 1994).
BANK REGULATION
---------------------------------------------------------- Chapter 2:2
Under the 1987 Act, the Bank is also responsible for issuing
regulations to implement the act, to clarify provisions in law, or to
provide guidance on the Bank's interpretation of requirements in the
Banking Act. It may do this in a number of ways. First, the Bank is
required under the 1987 Act to publish a statement of the principles
in accordance with which it will (1) interpret the criteria for
authorization and the grounds for revocation of a bank's
authorization established in the act and (2) exercise its power to
grant, revoke, or restrict an authorization. The Bank's Statements
of Principles are legally binding on the banks it supervises. For
example, the Statements of Principles discuss the Bank's expectations
on capital adequacy or liquidity which, therefore, must be adhered to
by banks.
The Bank also issues "supervisory notices" and "guidance
notes"--which also have the force of law--when, for example, amending
its Statements of Principles or updating previous notices. In fiscal
year 1994, the Bank issued five such notices on large exposures,
on-balance-sheet netting and cash collateral, the Bank's relationship
with auditors and reporting accountants,\2 reporting accountants'
reports, and subordinated loan capital.
Supervisory guidance may also include the issuance of a
"recommendation" on a certain issue by the Bank. There is an
expectation on the part of the Bank and the banks it regulates that
banks will make every effort to comply with Bank recommendations.
These recommendations do not directly carry the force of law,
although noncompliance could in certain circumstances call into
question whether a bank met the general criterion in the act
requiring institutions to conduct their business in a prudent manner.
This allows the Bank to be flexible in enforcing such
recommendations: it can take account of special circumstances which
may be discussed with individual institutions. For example, in April
1993 the Bank recommended that banks active in derivatives activities
have at least two board members knowledgeable about derivatives, of
whom one should be the Finance Director. This caused a problem for
some banks whose finance directors were not expert in derivatives,
even though at least two other Board members were. The Bank accepted
that it was reasonable to make an exception for such cases.
Before issuing supervisory notes or making recommendations, the Bank
will--as a practical matter rather than because it is required to do
so--get advice from and consult with interested parties such as the
British Bankers Association or the Auditing Practices Board. It is
also likely to request comment from the Treasury. Finally, the Bank
consults with the Board of Banking Supervision before issuing notices
or recommendations.
The Bank will also issue interpretive letters on its policies in
response to questions that it receives from individual banks. For
example, banks might have questions about how the Bank would
categorize a certain type of capital. This kind of interpretation is
viewed as binding on the bank.
Although the Bank is very involved in the drafting of banking
legislation and may be asked to testify before Parliament on
bank-related issues, the Treasury has the primary responsibility for
bank legislation. As a result, the Banking Act on several occasions
gives the Treasury the authority to change certain definitions or
requirements in the act and also provides that the Treasury may issue
regulations in some instances.\3
--------------------
\2 See chapter 3 for discussion of the responsibilities of auditors
and reporting accountants.
\3 For example, the act exempts a number of entities--such as the
Bank, building societies, or the International Monetary Fund--from
the restriction on deposit taking and allows the Treasury, after
consultation with the Bank, to add entities to or remove them from
the list. The Treasury may also make regulations with respect to the
act's subsection on acceptance of deposits and has the authority to
make advertising rules.
ENFORCEMENT ACTIONS
---------------------------------------------------------- Chapter 2:3
The Bank is solely responsible for taking enforcement actions against
banks "to ensure compliance with . . . standards and to protect
depositors and potential depositors." Nevertheless, the Bank is
subordinate to the Treasury and would notify the Treasury of any
significant action before taking it, and Bank officials said that the
Bank would abstain from taking a specific action if the Treasury
disapproved.
Enforcement actions are either informal, in which banks are strongly
encouraged to take an action, or formal, where actions by the
affected bank are required. The Bank has a great deal of discretion
to decide whether to take formal action or seek remedial action by
some other informal means--through persuasion and encouragement, for
instance. If, for example, "the Bank considers that adequate and
speedy remedial steps are likely to be taken by an authorized
institution," then it "would generally be reluctant to revoke or
restrict the authorization" and would be more likely to "recommend"
that certain actions be taken by a bank. Indeed, in the Statements
of Principles, the Bank further asserts that "where appropriate [the
Bank] will seek remedial action by [informal means such as]
persuasion and encouragement." This language reflects the Bank's
preference for informal over formal enforcement actions.
Informal enforcement actions are normally the Bank's first choice
because they are easier to put into effect, and provide for
flexibility to ensure that corrective actions are taken by the banks.
Furthermore, banks fully understand that if they do not comply with
informal actions and recommendations, then a strong formal action,
which the Bank has clear discretion to choose, is sure to follow.
Informal actions are, therefore, more effective than might otherwise
be assumed since banks recognize the formal authority which underlies
informal actions.
According to the Bank, such a system of supervision also works
because bank managers understand that if they notify the Bank of a
problem, Bank supervisors will help them find solutions and will not
discipline a bank for a problem that is being resolved. As a result,
many potential problems are brought to the attention of the Bank by
the banks themselves. Smaller banks in particular may not have the
expertise in-house to resolve certain problems and can turn to the
Bank for advice.
Nevertheless, the banking statute provides the Bank with powers to
take formal enforcement action against authorized institutions on a
number of grounds, particularly if the criteria for a bank to receive
approval to take deposits discussed above have been breached. Such
formal action can include revoking a bank's authorization; removing
bank managers or directors; or imposing conditions on the bank such
as limiting deposit taking to current depositors, restricting the
bank's scope of business, and prohibiting the bank from entering into
certain transactions.
Despite its preference for taking informal action, the Bank, in its
Statements of Principles, says that if it is necessary for the Bank
to take formal actions "in order to ensure compliance with the
standards or to protect the interests of depositors and potential
depositors [then] it will move to revoke or restrict authorization."
The Bank's Statements of Principles acknowledges that the threshold
for being authorized to take formal action under the Banking Act is
relatively low. For example, the Bank can take formal enforcement
actions to restrict or revoke a license "before the deterioration in
the institution's condition is such that there is a serious
likelihood that depositors will suffer a loss." It would, for
example, revoke an institution's license even if the institution had
adequate capital and liquidity if "there was no reasonable prospect
of speedy and comprehensive remedial action."
Both formal and informal actions are subject to judicial review. In
addition, formal enforcement actions are subject to review by the
Banking Appeal Tribunal,\4 as provided for in the Banking Act, and
the Board of Banking Supervision is informed by Supervision and
Surveillance of prospective formal actions that are being considered.
Appeals before the Tribunal are rare, however, and all but one
case--which was decided in favor of the Bank--have been withdrawn by
the appealing bank before a full hearing could take place. This fact
reflects the authority the Bank has over the banks it supervises and,
according to the Bank, the potential for appeal does not affect its
decisions to take formal action. Nevertheless, some banking industry
representatives have speculated that the Bank postponed decisions to
close BCCI because of the evidence that was deemed necessary to
forestall the possibility of an appeal to the courts.
In the 11-year period from March 1, 1983 through February 28, 1994,
the Bank used its powers to revoke bank authorizations 35 times\5 and
its power to restrict bank authorizations 47 times. In most cases,
such action is taken when the minimum criteria for authorization are
not being met.\6
While the Bank has sole authority to withdraw a bank's authorization,
the U.K. courts must be petitioned to close a bank, and the courts
officially decide whether an institution should be placed into
administration, receivership, or liquidation under the Insolvency Act
of 1986. Furthermore, in a majority of the cases where banks have
experienced sufficient solvency problems to warrant their closing,
the banks' directors or stockholders, not the Bank, have petitioned
the courts for an order closing the bank because this allows them to
play a role in determining who is appointed administrator of the
bank. Nevertheless, the Bank remains the driving force in
determining when and how a bank gets closed. For example, most
often, when banks petition the courts, they do so only after it is
clear from their discussion with bank supervisors that they have
little other choice. Furthermore, if the Bank decides that a bank
must be closed and that it should, for example, be placed in
receivership, then the court's approval is merely a formality.
If a bank is suffering from liquidity problems, the Bank will
encourage a bank to sell some of its assets, to get a line of credit
from other financial institutions, or, as a last resort, provide
liquidity itself. If these measures do not work, or if the bank is
suffering from solvency problems, the Bank will first turn to the
bank's largest shareholders to resolve the problem. If the
shareholders do not have sufficient resources, then the courts would
be petitioned to wind down the institution. Since 1987 there have
been nine bank failures in the United Kingdom.
--------------------
\4 The Tribunal is constituted on a case-by-case basis by three
individuals: a chairman--who must have legal experience and is
appointed by the Lord Chancellor of the Exchequer--and two other
members who have accountancy and banking experience and are appointed
by the Lord Chancellor.
\5 In most cases when the Bank has made a decision to withdraw a
bank's authorization, the bank has had sufficient capital to wind
down its operations without losses to depositors.
\6 Beyond its enforcement authority, which gives the Bank discretion
to revoke an authorization, there are two circumstances under the
Banking Act in which the Bank must withdraw a bank's authorization.
First, if the home supervisory authority of an EU member bank that
has branches in the United Kingdom withdraws its authorization of the
bank. Second, when a bankruptcy order has been made against the
institution in the United Kingdom.
THE BANK RELIES ON SEVERAL
SOURCES OF INFORMATION
---------------------------------------------------------- Chapter 2:4
To carry out its supervisory responsibilities the Bank relies on
several sources of information including banks, accountants,
auditors, and the financial markets. According to Bank officials,
the sources of information upon which they primarily rely are reports
submitted by, and meetings and other contacts with, the banks
themselves.
Statistical information on banks is received in electronically-filed
prudential reports, which are provided by the banks daily, weekly,
monthly, quarterly, semi-annually, or annually--as is considered
necessary by the Bank to fulfill its information needs. These
include detail on the banks' assets and liabilities and highlight the
main characteristics of a bank's business, such as its capital
adequacy, liquidity, large exposures, maturity analyses, foreign
currency exposures, industry exposure, dependence on connected
business, and derivatives activities. Banks must also report to the
Bank on such issues as management changes, proposed changes in
ownership, and branch openings.
In addition, the Bank receives on-site information about banks from
reports by the banks' reporting accountants and conducts its own
reviews through small review teams and, more infrequently, by special
investigation teams, as discussed in chapter 3.
The Bank also relies on information it receives from banks in formal
bilateral meetings and also from informal meetings and telephone
calls with them. It attaches considerable importance to regular
interviews with senior management from each institution to discuss
and elaborate on the information received in prudential reports.
Through these interviews, the Bank attempts to assess the
capabilities of bank management to control the business, achieve the
institution's objectives, and satisfy itself that the criteria for
authorization continue to be met.
In the 12 months between March 1, 1993, and February 28, 1994, the
Bank held over 3,000 "routine" and "nonroutine" meetings with
banks.\7 Of these, over 1,000 were routine prudential or trilateral
meetings to discuss the banks' performance, business, systems and
controls, and compliance with requirements such as capital and
liquidity minimums that have been agreed to between the Bank and
individual banks.\8 Most of these routine meetings were prudential
interviews: 401 were interviews with banks incorporated in the
United Kingdom, and 283 were with branches of foreign banks. An
additional 357 routine meetings were trilateral meetings that
included the banks and the banks' reporting accountants as
participants (see discussion on auditors and reporting accountants in
chapter 3 for further information).
The Bank also held nearly 2,000 nonroutine, but formal meetings with
banks to discuss specific issues about which the Bank wanted more
information. Topics at such meetings could include: individual
supervisory concerns, changes in bank management, plans to expand
into new areas, or suitability of controllers--managing directors,
chief executives, or stockholders owning 15 percent or more of the
voting stock of a bank--to name only a few.
More informally, bank management will often meet with or telephone
Bank staff to discuss future plans, potential problems, or other
issues if they wish to obtain Bank opinions, informal approval, or
advice.
In addition, the Bank has contracts with other participants in the
financial markets that also provide it with more informal information
about the banks it supervises. For example, the Bank might be told
that participants in the foreign exchange market have limited their
counterparty exposure to a particular bank because of concerns about
the bank's operations. Or the Bank may hear that a senior manager at
a particular bank has been borrowing heavily or speculating in the
markets, which might raise concerns about his or her suitability to
manage a bank. Although such information is often subjective, it may
provide the basis for the Bank to follow up with the banks or their
reporting accountants.
In all cases, Bank staff may follow up on information received with
written or oral requests for further information, meetings with banks
and/or their accountants, or visits to the banks by Bank review teams
or special investigation teams.
--------------------
\7 As noted earlier, there are approximately 500 banks in the United
Kingdom, 232 incorporated in the United Kingdom and 286 incorporated
outside the United Kingdom.
\8 The Bank adheres to minimum capital and liquidity requirements set
out in EU directives that were modeled on the Basle Committee on
Banking Supervision recommendations, which the Bank played a
significant role in developing. However, these requirements are
considered to be minimums and the Bank will discuss acceptable
capital and liquidity levels individually with the banks it
supervises. According to the Bank's Statements of Principles, "the
Bank sets a trigger ratio for individual banks according to an
overall assessment of the risks that they face and the quality of
their risk management. A bank is required to meet its trigger ratio
at all times. In order to lessen the risk that the trigger ratio
might be breached, the Bank generally expects each institution to
conduct its business so as to maintain a higher ratio (the target
ratio)." See International Banking: Implementation of Risk-Based
Capital Adequacy Standards (GAO/NSIAD-91-80) for additional
information on risk-based capital standards.
THE BOARD OF BANKING
SUPERVISION ADVISES THE BANK
---------------------------------------------------------- Chapter 2:5
As noted in chapter 1, the Board of Banking Supervision was
established in the 1987 Act as an independent committee advising the
Bank's Court of Directors and consists of three ex-officio Bank
members and six independent members. According to a paper issued by
the Treasury at the time, the Board was intended to bring independent
commercial banking experience to bear on banking supervisory
decisions at the highest level. The independent members have a
responsibility to advise the Board's ex-officio members on the Bank's
actions taken under the authority of the act, either generally with
respect to matters of policy or in relation to particular
institutions.
Questions about individual institutions can range from new
applications for authorization and proposals for changes of control
to concerns on the part of the Bank about the suitability of
controllers, possible threats to the interests of depositors, or
formal enforcement actions that are being considered to resolve
problems. For example, the Board met numerous times over the
problems associated with BCCI and eventually endorsed the Bank's
decision to close BCCI. In addition to institution-specific issues,
the Board will also address broader policy issues, and it reviews the
staffing and training arrangements for Supervision and
Surveillance.\9
If the Bank decides not to accept the advice of the independent
members of the Board, then the Banking Act requires the ex-officio
members of the Board to give written notice of that fact to the
Chancellor of the Exchequer. This has happened only once.\10
The Board generally meets once a month, although during crises it
meets more often. Minutes of the Board's meetings are provided to
those of the Bank's directors who request them. The nonexecutive
directors of the Bank (those who are not officials of the Bank) and
the six non-Bank members of the Board of Banking Supervision also
meet once a year to discuss issues of interest, including the Bank's
annual report and accounts and the annual report required under the
Banking Act.
In order to resolve some supervisory weaknesses that came to light
after the BCCI failure, procedures for involving the Board of Banking
Supervision in the Bank's Supervision and Surveillance area's work
have been strengthened. For example, internal guidance on when to
report matters to the Board has been tightened, and those cases about
which the Board's advice is specifically sought are highlighted. In
general, according to Bank officials, the Board's advice has been
very helpful and effective over the years since its establishment.
--------------------
\9 According to the Board's annual reports, policy questions that
have come before the Board have included the implications for banks
of changes in the markets in which they participate, questions of
provisioning against sovereign risk, arrangements between the Bank
and other U.K. financial institutions regulators with respect to
their separate regulatory responsibilities, the ownership of U.K.
banks, and implications for the banking system of Iraq's invasion of
Kuwait.
\10 In this case, based on confidentiality requirements in the
Banking Act of 1987, the Board in 1991 advised against the Governor's
testifying before Parliament on the specifics of the BCCI case for
fear of creating the precedent of speaking before Parliament about an
individual case. The Governor made the decision not to take the
advice of the Board and notified the Treasury as required under law.
INDUSTRY SATISFACTION WITH THE
BANK AS BANK SUPERVISOR
---------------------------------------------------------- Chapter 2:6
While the failure of BCCI has opened a public debate on the role of
the Bank as bank supervisor, in general the banks we interviewed, and
the British Bankers Association, speaking for its membership, believe
that the regulatory and supervisory system in the United Kingdom
works fairly well. The Bank is perceived as a prudent, but not
onerous regulator and a pragmatic supervisor. The banks appreciate
that the Bank operates with discretion but that it also gets the job
done. Although the failure of BCCI dealt a blow to the reputation of
the Bank, banks we interviewed continue to believe that the Bank is
doing a better job than bank regulators in systems where supervisors
are more intrusive.
Some representatives of the accounting firms we talked to were
slightly more critical. For example, questions were raised about
whether the Bank was firm enough with banks experiencing problems and
whether concerns about the economy might be affecting bank
supervision.\11 However, these representatives felt that the
additional information being required by the Bank on bank records and
systems would be useful to the Bank in understanding routine
financial reports banks submitted to the Bank (see ch. 3 for
additional discussion).
--------------------
\11 See appendix II for discussion of potential conflicts of interest
between the Bank's role as monetary authority and bank supervisor.
THE BANK CONDUCTS LIMITED BANK
REVIEWS AND USES REPORTING
ACCOUNTANTS AND EXTERNAL AUDITORS
TO OBTAIN ADDITIONAL ON-SITE
INFORMATION
============================================================ Chapter 3
The U.K. supervisory approach does not depend on full-scope, on-site
examinations of authorized banks.\1 Accounting firms carry out
on-site work at banks in their formal roles as reporting accountants
appointed under the Banking Act to produce reports on any relevant
matter, as well as their role as external auditors appointed under
the Companies Act. The Bank also has its own small staff (review
teams) that carry out short visits to banks on an informal basis as
specific needs arise. Bank supervisors are provided with the reports
commissioned by them from reporting accountants and the results of
the visits of the Bank's own review teams. These reports and the
results of the review teams' visits, together with information
collected directly from banks (as described in ch. 2), and
trilateral meetings with the banks and accountants are intended to
give supervisors a complete picture of the banks for supervisory
purposes.
--------------------
\1 Full-scope examinations include examining bank asset quality,
assessing banks' systems and internal controls, judging capital
adequacy and reserves, and assessing compliance with laws and
regulations.
BANK STAFF CONDUCT LIMITED
ON-SITE BANK REVIEWS
---------------------------------------------------------- Chapter 3:1
The Bank has the authority under the 1987 Act to enter the premises
of a bank to obtain information or documentation. While it does not
use this power to conduct full-scope examinations, the power enables
the Bank to carry out limited bank reviews on an informal basis,
drawing from a small group of 11 review team members. The group
currently includes four accountants from major accounting firms,
three bankers from large banks who have all been assigned for two
years to the Bank of England as well as four Bank staff, and former
bankers who are on contract to the Bank.
The reviews are conducted in small "review" teams of two or three,
with at least one accountant and one banker on each team. In
addition, a Supervision and Surveillance career line supervisor
usually accompanies the review team in order to obtain first-hand
information about the banks for which he has responsibility. The
teams assess the quality of banks' lending and the adequacy of their
systems and controls. For example, they may check a bank's treasury
operations, its electronic data processing systems, or its credit
area. Visits by review teams can range from 2 to 3 days to several
weeks and may cover locations throughout the country. Review team
visits in smaller banks may cover the full range of a bank's
activities, whereas in larger banks the teams may concentrate on a
specific line of business.
Reports by review teams tend to be fairly qualitative since visits
are short and much of the review team information is derived from
interviews rather than documents. Nevertheless, a Bank official
stated that such subjective reports often provide helpful information
that gives a flavor of the bank's operations that cannot necessarily
be derived from an accountant's report or bank audit. After its
visit, the review team will hold a closing meeting with the bank's
management to discuss initial conclusions. The review team will then
draft a detailed report that will be provided to the bank's
supervisor who will, in turn, discuss the report with the bank and
provide a list of significant points to be resolved.
In principle, review teams are meant to visit all 518 banks in the
United Kingdom, including foreign branches, although not on an annual
basis. In practice, visits to the 129 European-authorized
institutions tend to be rare and are largely confined to liquidity
and money laundering since primary supervisory responsibility over
these banks rests with the home supervisory authorities. Banks about
which the Bank has no concerns are also not given high priority for
review team visits. In the year ending February 28, 1994, the Bank
carried out 112 review team visits and 11 additional "special"
visits. Special review teams will focus on specific issues when the
Bank suspects a problem.
The Bank also conducts reviews of banks' foreign exchange operations
and assesses their compliance with Bank guidelines. In such reviews,
Bank staff will review specifically the position limits that the Bank
has set with individual institutions as well as other issues such as
netting arrangements and general business strategies. These reviews
are conducted by staff within Supervision and Surveillance--generally
one senior manager assisted as necessary by detailed accountants and
bankers, and/or experienced analysts from within the supervisory
divisions. The Bank conducted 41 such visits in the year ending
February 28, 1994.
Both review team visits and foreign exchange visits are conducted
with the cooperation of the institution and do not explicitly involve
the use of the Bank's statutory powers. In principle, this means
that a bank could refuse entry to the Bank's teams, although such a
case has never happened and is unlikely to happen given the Bank's
arsenal of statutory powers to obtain information. If a bank were to
refuse entry, the Bank would have to use its statutory powers to
require the bank to cooperate, which, according to a Bank official,
"would clearly be at odds with the spirit within which we normally
conduct our supervision."
As a result of recommendations resulting from investigations into the
BCCI failure, the Bank established a special investigations unit
(SIU) with 11 staff including support staff, made up of both
experienced banking supervisors and specialist forensic accountants
recruited from major international accounting firms. According to a
Bank of England Banking Act Report, "the SIU now acts as the focal
point for all cases where there are concerns about possible criminal
activity involving institutions for which the Bank has supervisory
responsibility." The primary role of the SIU is to advise Bank
supervisors on appropriate actions to take in pursuing suspicions and
warnings of fraud and other criminal activity based on information
provided by the supervisors. Special investigation teams will also
investigate such cases when appropriate.
REPORTING ACCOUNTANTS
CONTRIBUTE TO EXAMINATION
FUNCTION
---------------------------------------------------------- Chapter 3:2
In the United Kingdom, reporting accountants perform a significant
part of the examination function through annual and special reviews
provided for in the 1987 Act. All banks in the United Kingdom, with
the exception of European-authorized institutions,\2 are subject to
two types of reviews under the act: (1) an annual records and
controls review required by section 39 of the 1987 Act (records and
controls audits), as requested by the Bank;\3 and (2) special reviews
of individual banks, under section 41 of the 1987 Act, that may be
requested by the Bank if it perceives a need for additional
information, for example, with respect to suspected fraud or
unexpected losses (special reviews). While reporting accountants
must comply with Bank requests for such reports, the Bank has no
access to accounting firms' work papers.
Accountants were assigned their responsibilities under the Banking
Act of 1987 not only because it was seen as the most efficient way of
introducing the necessary checks on systems and controls by drawing
on an existing pool of expertise, but also because the Bank preferred
its traditional approach of supervising banks "based on dialogue,
prudential returns and trust"--which it believes has served it
well--rather than more intrusive examination techniques.
In addition to reviews conducted under the Banking Act, external
auditors conduct annual financial audits that are required of all
U.K. corporations under corporate law. These audits may also be
used by the Bank in the supervisory process.
--------------------
\2 European-authorized institutions are those incorporated in the EU
or in the EEA (but outside the United Kingdom) and are not required
by the bank to have annual systems and control audits. The Bank, on
a case-by-case basis, may periodically require such an audit, but it
would generally be limited in scope to audits of prudential returns.
European-authorized institutions are also generally not subject to
special audits that may be requested by the Bank. On February 28,
1994, there were 129 European authorized institutions in the United
Kingdom, 97 of which were allowed to take deposits.
\3 Under the law, the Bank is given the authority to request records
and controls reviews. The Bank has used this authority to require
such reports annually.
THE BANK USES ANNUAL RECORDS
AND CONTROLS REPORTS TO HELP
ASSESS RECORDS AND SYSTEMS
-------------------------------------------------------- Chapter 3:2.1
The 1987 Act explicitly requires banks to maintain accounting and
other records and internal control systems that enable a bank to
prudently manage its business and to comply with legal requirements.
To monitor compliance with this requirement, the Bank has been given
the right under section 39 of the 1987 Act to require that banks hire
accounting firms--called reporting accountants for the purposes of
section 39 reporting--to conduct annual reviews of a bank's records
and systems of controls and to check the statistical and other
prudential reports banks submit to the Bank. The records and systems
and prudential return reviews are frequently separate assignments
carried out under their own letters of instruction. Furthermore, a
prudential return review will always result in a separate report
being issued by the reporting accountant to the Bank.
The Bank uses information from the annual records and controls
reports to assist it in judging the adequacy of a bank's records and
systems and whether the bank's business is conducted in a prudent
manner on a day-to-day basis. The Bank does not expect reporting
accountants to make a judgment about prudent conduct, but it does
want them to set out the risks that the institution runs by not
correcting the weaknesses the accountants have identified. Records
and controls reports do not, however, express an opinion on the
bank's financial statements.
Records and controls reviews are paid for by the bank being reviewed,
and the reports are submitted to the bank for comment before the
report and the bank's comments are provided to the Bank. The scope
of the report, however, is set by the Bank in annual discussions it
holds with the banks and their reporting accountants and is formally
communicated to reporting accountants in annual letters sent them by
the banks.
The Bank's policy is to require full-scope records and controls
reviews on an annual basis for "small or vulnerable" banks.\4
The Bank expects a full-scope review to include a consideration of
the adequacy of the accounting and other records and internal control
systems, including the internal audit function, throughout the
institution. The reporting accountant is also expected to check the
institution's procedures with respect to preventing, detecting, and
reporting suspicions of money laundering.\5 Larger banks get rolling
records and controls reviews since full-scope reviews would take too
long and would be prohibitively expensive. A records and controls
report of a larger bank might cover the bank's high-level controls in
one year, then its treasury activities in another, and its credit
activities in a third, for example.
--------------------
\4 If a bank or branch has received positive records and controls
audit reports for several years in a row, it may be permitted a year
in which no report is required.
\5 While the Bank's guidance in this area states that the procedures
to be covered are those relating to "preventing, detecting, and
reporting," an accounting firm with which we spoke brought to our
attention that the Bank confirmed with them that the notice should
refer to procedures for "prevention, deterrence, and reporting." The
reason for this is that the U.K. legislation on money laundering
requires banks (and others) to maintain systems for deterrence but
not for detection (which would be overly onerous). This was
confirmed by the Bank.
THE BANK HAS ISSUED GUIDANCE
ON ANNUAL RECORDS AND
CONTROLS REVIEWS
-------------------------------------------------------- Chapter 3:2.2
The Bank does not have detailed requirements about the manner in
which annual records and controls reviews should be conducted.
Rather, it has issued 17 pages of guidance that emphasize the scope
and nature of the financial information, which accounting and other
records must be designed to capture, and the scope and nature of
internal control systems.\6 The guidance also includes three pages on
the reporting accountants' reviews and reports.
The guidance requires that adequate records be maintained to
facilitate the prudent day-to-day conduct of a bank's business,
compliance with statutory reporting requirements, and provision of
appropriate information for the bank's own statistical and prudential
returns. Information provided to management for the day-to-day
conduct of a bank's business should be sufficient to enable it to (1)
monitor the quality of its assets and safeguard them; (2) identify,
control, and manage risk exposures; (3) make timely and informed
decisions; and (4) monitor the current performance of all aspects of
the business.
With respect to internal controls, the Bank recognizes that internal
control systems will vary from bank to bank, but controls should
"provide reasonable assurances that a bank's revenues accrue to its
benefit, all expenditure is properly authorized and disbursed, all
assets are adequately safeguarded, all liabilities are recorded, all
statutory requirements relating to the provision of accounts are
complied with, and all prudential reporting conditions are adhered
to." The Bank does not require, but strongly encourages, the
establishment of an internal audit function and audit committees. As
a result, most U.K. banks have established audit committees and
internal control functions. The Bank recommends that the internal
audit function should be responsible directly to the board's audit
committee. In its notice, the Bank states that control functions
that could be undertaken by an internal audit department may include:
undertaking special investigations for management; reviewing
accounting records and the control environment; reviewing
appropriateness, scope, and efficiency of internal control systems;
and reviewing implementation of management policies.
In its guidance on reporting accountants' reviews and reports, the
Bank asserts its expectation that reporting accountants abide by the
accounting industry's guidelines. The Bank also requires reporting
accountants to give an overall assessment of the control environment
for each business area that they have been asked to examine. As of
year-end 1994, records and control reports by reporting accountants
are also to include background information on the business areas in
which systems were reviewed including the organizational structure,
nature, and approximate volume of transactions, the key risks faced
by the institution, and the key controls in operation.\7
In conducting annual records and controls work, reporting accountants
are "required to form an opinion on whether the institution's
accounting and other records and internal control systems have been
maintained by management in accordance with the Bank's interpretation
of the requirements of the Act." In separate reviews, reporting
accountants will check whether the material in certain prudential
reports selected by the Bank has been properly extracted from the
underlying accounting records. They are not required to check the
accuracy of the underlying records, however. Over a period of years,
the records and controls reports on each institution are to cover all
relevant prudential reports.
Until this year, records and controls reports had been quite short.
They consisted of a one-page letter to the directors of the bank with
an appendix describing the exceptions to the Bank's criteria for
adequate records and controls. Most reports have several pages of
exceptions, while only a few will not have any exceptions. It is
also relatively rare that a negative report will be issued.\8
Guidelines on annual records and control reviews have also been
adopted by the Auditing Practices Board (APB), an industry group
similar to the American Institute of Certified Public Accountants in
the United States, after close consultation with the Bank. The Bank
expects that records and controls work will be conducted in
accordance with its guidelines as well as those of the APB.
--------------------
\6 "Guidance Note on Reporting Accountants' Reports on Accounting and
Other Records and Internal Control Systems," (Mar. 1994).
\7 This information was requested by the Bank because the listings of
exceptions provided by the reporting accountants were often cryptic
and difficult to understand without some basic descriptive
information about the bank's systems and controls.
\8 An annual records and controls audit opinion will read one of two
ways. A positive report with exceptions will read: "in our opinion,
having regard to the nature and scale of its business, during the
year ended [ ] the accounting and other records and internal control
systems examined by us were established and maintained in accordance
with the requirements of the Guidance Note (with the exception of the
matters set out in Appendix 3 attached to this report)." A negative
report will read: "in our opinion, having regard to the nature and
scale of its business, during the year ended [ ] the accounting and
other records and internal control systems examined by us were not
established and maintained in accordance with the requirements of the
Guidance Note for the reasons set out in Appendix 3 attached to this
report."
SPECIAL REVIEWS MAY BE
REQUESTED IF THE BANK HAS
SPECIFIC CONCERNS
-------------------------------------------------------- Chapter 3:2.3
Under section 41 of the 1987 Act, the Bank may also request that a
reporting accountant conduct a special review if the Bank has
specific concerns about a bank. In such cases, the Bank hires the
accountant, pays the accountant, and sets the scope of the review.
The Bank's authority to request information under section 41 is very
broad, and reviews may cover the full operations of a bank or a
specific area about which the Bank has concerns.
Special reviews are conducted on very short notice or even
secretly--for example, during the course of a regular annual records
and controls review--and reporting accountants report on their
reviews directly to the Bank in bilateral meetings. The accountants
do not first discuss the results of the special review with the bank.
The Bank may use the bank's own accountant to conduct a special
review if, for example, the Bank feels that it is easier to use an
accountant already familiar with the bank, or it may choose another
accountant if it wants a completely independent opinion. For the
special review of BCCI, the Bank used Price Waterhouse, BCCI's annual
auditor and accountant, without giving notice to BCCI that the review
was being conducted.
Special reviews are not requested very frequently, averaging slightly
more than four a year over the past 10 years, partially because of
the high cost of such reviews to the Bank. Nevertheless, the Bank
says that it does not let concerns about cost stand in the way of
commissioning a special review.
In order to avoid the cost of a special review, the Bank may send in
its own special investigations teams for smaller banks, or it may
request a bank to commission a special records and controls report
about a specific area of concern. Such a report has the advantage of
being paid for by the bank being reviewed, but the bank also is
notified of the review and may have time to hide evidence of
wrongdoing.
BANKS ARE ALSO SUBJECT TO
ANNUAL AUDITS UNDER CORPORATE
LAW
---------------------------------------------------------- Chapter 3:3
Corporate law in the United Kingdom, the Companies Act of 1985 (1985
Act), requires all companies incorporated in the United Kingdom to
receive annual financial audits.\9 The scope of such a statutory
audit of a bank's financial statements is no different from that of
any other company. External auditors are required to report whether,
in their opinion, the annual financial statements give a true and
fair view and have been properly prepared in accordance with the 1985
Act. Aspects of a bank's business typically examined would include:
checking that the bank is complying with capital requirements;
assessing asset quality, loan loss reserves, earnings, and management
capability; and reviewing internal controls.\10 In carrying out their
audit work and in preparing their report on the financial statements,
auditors comply with auditing standards prepared by the auditing
profession. There are no financial audit requirements imposed by the
Bank.
There is also no requirement that financial auditors hired under the
1985 Act's requirements provide the Bank with the management letter
they send to the bank's directors describing the results of the
audit. However, if a Bank supervisor requests a copy of the
management letter, which can be quite detailed, then the bank will
provide one after consulting with its auditor.
--------------------
\9 At the end of February 1994, there were 232 banks incorporated in
the United Kingdom that were required to receive annual audits.
Branches of banks incorporated outside the United Kingdom are not
required to receive audits, but many do, depending on the audit
requirements in the bank's home country. The exact percentage of
foreign branches that receive annual audits is not available,
although some of the accountants we interviewed estimated that about
50 percent do. However, even when branches are audited, these audits
are often not full financial audits.
\10 Management capability and internal controls are assessed as a
basis for the production of reliable financial information and are
not within the scope of the statutory audit opinion.
THE ROLE OF REPORTING
ACCOUNTANTS AND EXTERNAL
AUDITORS CONTINUES TO EVOLVE
---------------------------------------------------------- Chapter 3:4
The role of reporting accountants and external auditors and the
content of the reviews they must conduct under the Banking Act has
continued to evolve since 1987. For example, as of May 1, 1994,
under a new provision recently added to the 1987 Act, reporting
accountants and financial auditors must not only report the
information requested under the 1987 Banking Act and the Companies
Act but also have a statutory duty to report to the Bank any material
breaches in the minimum authorization criteria that they discover
during the normal course of their review and audit work (see ch.
2).\11 Such breaches must be reported without undue delay. Financial
auditors must also report to the Bank if they have reason to believe
that their audit opinion will be qualified, and reporting accountants
have a similar duty to the Bank if they decide to issue an adverse
report. In general, bank audits are qualified only rarely.
Reporting accountants and external auditors may use their own
judgment with respect to whether such information should first be
reported to their client. Furthermore, according to the accounting
firms with whom we spoke, they will often try to persuade their
clients to report to the Bank directly, instead of having the
accounting firm report. When there is written evidence that a matter
has been communicated to the Bank in full by bank management, and the
accountant or auditor has adequate evidence from sources independent
of the bank that the Bank is fully aware of all relevant information,
then the accountant or auditor is not required to report that same
information. There are, nevertheless, a number of
situations--particularly those which cast doubt on the integrity or
competence of directors and management--in which the auditor or
accountant should report directly to the Bank, without discussing it
with management. The exact legal responsibility for what the auditor
or accountant should report and when he or she should report it
remains subject to interpretation, however, since the requirement is
still relatively recent and untested.
--------------------
\11 The statutory duty to report to the regulator also applies to
auditors of all other financial companies, such as securities firms,
insurance companies, friendly societies, and building societies.
THE BANK HOLDS ANNUAL
TRILATERAL MEETINGS WITH
REPORTING ACCOUNTANTS, BANK
AUDITORS, AND BANKS
-------------------------------------------------------- Chapter 3:4.1
After the Bank receives the reporting accountant's records and
controls report, it is to commission a trilateral meeting with the
bank's reporting accountant--who, in most cases, is also the bank's
financial auditor--and the bank.\12 Participants in the meeting will
include the bank's Bank supervisor and the supervisor's assistant,
representatives of the bank, and representatives of the accounting
firm. On average, these meetings will last about 2 hours. At these
meetings, the participants discuss the following five different
agenda items:
(1)The key accounting and auditing issues that came out of the annual
financial audit, as required by the 1985 Companies Act.
(2)The section 39 report on records and control systems. The
supervisor will generally address each exception in the report, the
reporting accountant will explain the exception, the bank comments,
and then solutions to the problems are discussed and future actions
to deal with the problems decided upon.
(3)The reporting accountant's report on the bank's prudential returns
to the Bank and any exceptions in that area, as required under
section 39 of the Banking Act.
(4)The scope for the following year's report.
(5)Any other business. Under this agenda item, for example, the Bank
would formally notify the accountant of any matters about the
accountant's bank client that it felt were of concern and that the
accountant should know about.
Trilateral meetings are generally not very contentious and in most
cases the accountant and bank have agreed on the records and controls
report before the meeting. Nevertheless, the accountant and bank
sometimes agree to disagree and both present their cases to the Bank,
according to both officials of the Bank and the accountants with whom
we spoke.
There are generally no further communications between a reporting
accountant and the Bank on a specific bank unless the accountant
finds a serious problem with a bank during the course of his or her
work or if, for example, the accountant simply wants to clarify a
technical question. There is a strong feeling within the accounting
profession, according to the accountants and the banks we
interviewed, that all communications with the Bank should pass
through the client bank. However, the Bank and accountants might
meet on a variety of nonclient specific issues that are of common
interest to both the accountant and the Bank, such as new APB
auditing standards or Bank guidelines.
--------------------
\12 If the reporting accountant is not the bank's financial auditor,
a separate meeting is generally held with the financial auditor to
discuss the annual financial audit.
EXTERNAL ACCOUNTING FIRMS
ARE SUBJECT TO UNLIMITED
LIABILITY
-------------------------------------------------------- Chapter 3:4.2
The work of bank external accounting firms is subject to unlimited
liability--several and joint--whether they are acting as reporting
accountants or financial auditors. Furthermore, according to an
accountant with whom we spoke, it is expected when a bank fails that
its auditor will be sued, generally because the auditor has given an
unqualified opinion that the bank's accounts gave a true and fair
view of the bank's affairs that showed the bank was solvent and yet
the bank failed in the following year. Nevertheless, lawsuits over
bank audits have not been frequent in the United Kingdom since banks
have not failed often; there have been nine bank failures involving
the Deposit Protection System since 1987.\13 However, lawsuits
involving bank failures often involve large amounts of money. For
example, at one extreme, Price Waterhouse, the auditor of BCCI, is
being sued for $8 billion over its audits of BCCI before its failure.
Lawsuits are generally brought by bank creditors.\14 The Bank may
also sue accounting firms for losses it suffers from a bank failure;
for example, if it provided liquidity lending that was not repaid.
However, the Bank has only sued an accounting firm once in its
capacity as owner of JMB after it helped rescue the bank.\15
Accounting firms are protected under section 47 of the 1987 Act from
claims of breaching client confidentiality when they communicate
information about a client to the Bank, if such a communication is
made "in good faith." Such protection is granted in cases where the
Bank specifically requests information as well as in cases where the
accountant or auditor approaches the Bank with information.
--------------------
\13 While there have been many more revoked
authorizations--approximately 35 since 1983--most of these have
involved an orderly winding down of a bank's business and are not
considered to be failures.
\14 While bank stockholders may sue, they must sue individually since
there is no class action suit in the United Kingdom. This
restriction makes stockholder suits less likely.
\15 That lawsuit was settled out of court.
THE BANK MAY TAKE ACTION
AGAINST REPORTING ACCOUNTANTS
---------------------------------------------------------- Chapter 3:5
The Bank consciously decided not to require specific qualifications
for reporting accountants/bank auditors nor to have a list of
approved auditors because it did not want to make it too difficult
for auditors to qualify to audit or review banks. Nevertheless, the
Bank uses primarily the "big six" accounting firms (see p.19) when it
commissions special reviews under section 41 and even though the Bank
may not dictate who a bank's statutory auditor should be, it has
sometimes implied that banks switch from smaller accounting firms to
one of the big six without recommending a particular firm, according
to a Bank official.
Furthermore, the Bank has the right to request that a bank change its
reporting accountant or that the accounting firm's partner
responsible for the bank be changed. Since a bank's reporting
accountant and its financial auditor are almost always the same firm,
the Bank, in effect, has some control over a bank's financial
auditor. There have been cases where banks have changed accounting
firms as a result of Bank dissatisfaction.
Even though formal disapprovals of reporting accountants/bank
auditors are rare, the Bank is more frequently not fully satisfied
with the work being done by section 39 reporting accountants and
financial auditors. According to a Bank official, there have been a
few cases where banks have had to make significant provisions to
reserves shortly after an audit was completed, and questions were
therefore raised about the quality of the audit work. In other
cases, Bank review teams have visited a bank after it was audited and
required additional provisions, which again raised questions about
the bank's auditor.
When the Bank is dissatisfied with the work of a particular firm or
of a firm's partner, it is likely to call the firm's senior bank
partner to discuss the problem. Generally, this will be sufficient
to address a problem or perceived problem. At the extreme, the Bank
would request that a bank dismiss its auditor or accountant, as
discussed above.
The Bank also recognizes that potential conflicts of interest between
the accountant's responsibilities to his client and to the Bank may
affect the quality of work. But senior regulators believe that the
accountants are careful to guard their reputations and would,
therefore, not allow the potential conflict to seriously affect their
work.
THE BANK HAS LINKS WITH DEPOSIT
PROTECTION BOARD AND HAS OTHER
BANK-RELATED RESPONSIBILITIES
============================================================ Chapter 4
The Bank's Governor chairs and the Bank provides staff to the
independent Deposit Protection Board, which administers the deposit
protection system. In addition to its role in bank regulatory and
supervisory matters, the Bank has responsibilities in other
bank-related activities such as liquidity provision, crisis
management, payments clearance, international negotiations, and
lender of last resort.
THE BANK HEADS INDEPENDENT
DEPOSIT PROTECTION BOARD
---------------------------------------------------------- Chapter 4:1
The U.K.'s deposit protection system was established under the
provisions of the 1979 Act and revised in the 1987 Act and is
mandatory for all banks in the United Kingdom. The deposit
protection system covers 75 percent of pound sterling deposits in the
United Kingdom, but not in foreign branches of U.K. banks, up to
�20,000. Thus, the most an individual can collect in a bank failure
is �15,000.\1
The Deposit Protection Board administers the deposit protection
system and controls the Fund that pays out claims. The Board's sole
function is to administer the deposit protection system. It has no
regulatory or oversight function, nor does it assist in problem bank
situations; it only steps in when a bank becomes insolvent and
depositors are due funds.
The Deposit Protection Board is an independent body legally separate
from the Bank, even though four of the Board's seven members are Bank
officials, including the Board's chairman, who is the Governor of the
Bank of England. The other three Bank officials on the Deposit
Protection Board are the Bank's Deputy Governor, its executive
director in charge of banking supervision, and its chief cashier.
The three non-Bank Board members are bank representatives.
The Fund is maintained through contributions made by banks to the
Fund. It is required by law to maintain a level of �5 million to �6
million--a small fraction of the approximately �550 billion in
sterling deposits held by U.K. banks as of March 1994--and banks may
be required to make three types of contributions to maintain this
level of funding: (1) initial contributions of �10,000 when a bank
is first authorized; (2) further contributions, if the Fund falls
below �3 million, not exceeding �300,000 per bank based on the
insured deposit base of the banks involved; and (3) special
contributions, again based on the insured deposit base of the banks
involved, but with no contribution limit. Since the largest six
banks in the United Kingdom hold 55 percent of the insured deposits
in the United Kingdom, they would cover 55 percent of these special
contributions. Special contributions of �80 million were necessary
to fund expenditures after the BCCI failure.
If necessary, the Fund may borrow from the Bank--which it did after
BCCI was closed in 1992. The limit of this line of credit is set by
the Treasury and is subject to annual review. The line of credit was
increased to �125 million in 1992 then reduced to �50 million in
1993. The line of credit is intended for short-term, liquidity
purposes until the Deposit Protection Board can raise the funds from
its member banks to repay the Bank loan. The Fund receives no direct
financial backing from the Bank or the U.K. taxpayer. If a
situation developed in which major banks would be jeopardized by
contributing the necessary funds to resolve a large bank failure, the
matter would be addressed at a political level at that time.\2
--------------------
\1 These limits will change on July 1, 1995, when EU directives are
implemented. Coverage will increase to 90 percent of deposits in any
EU currency including deposits in EU branches of U.K. banks, with a
maximum recovery of 20,000 European Currency Units (ECU), about
�18,000. The ECU is a basket of European currencies consisting of
specific amounts of 10 EU member states' currencies. Furthermore,
banks authorized in other EU member countries will carry the deposit
protection of their home countries and will, therefore, no longer be
required to participate in the U.K. system.
\2 For additional information on deposit insurance in the United
Kingdom, see Deposit Insurance: Overview of Six Foreign Systems
(GAO/NSIAD-91-104, Feb. 22, 1991).
THE BANK'S OTHER BANK-RELATED
RESPONSIBILITIES
---------------------------------------------------------- Chapter 4:2
The Bank's bank-related responsibilities are not limited to
supervision and regulation. It also plays a role in liquidity
provision, crisis management, payments clearance, the negotiation of
international agreements, and acts as lender of last resort.
LIQUIDITY PROVIDER
-------------------------------------------------------- Chapter 4:2.1
The Bank undertakes daily operations in the U.K. money markets. The
Bank supplies money to the banking system (or withdraws it from the
system and the economy) to conduct monetary policy. These flows are
concentrated across a small number of accounts--those of bigger
banks--at the Bank.
The terms at which the Bank supplies liquidity are interpreted as a
signal about the Treasury's desired level of short-term interest
rates and, as such, have a general influence over interest rates.
CRISIS MANAGEMENT
-------------------------------------------------------- Chapter 4:2.2
The Bank has taken a major role in crisis management involving
financial institutions, both as a result of its role as lead
regulator of banking firms and as a major participant in financial
markets. Even though the Treasury has no formal role in banking
supervision, the Bank would, as a matter of policy, keep the Treasury
informed of potential crises.
The key role of any central bank is to supply sufficient liquidity to
the financial system in a crisis. For example, after the 1987 market
break, the Bank announced its intention of providing liquidity to the
market, thereby giving its unofficial endorsement to the view that
the banks at the center of the system would be able to meet their
obligations in any event.
The Bank has, with greater and lesser degrees of success, also
persuaded major U.K. banks to support rescue operations of
individual or groups of banks. In the early 1970s, for example, a
number of relatively unsupervised secondary banks experienced severe
financial problems, primarily as a result of real estate speculation.
The secondary bank crisis threatened serious repercussions on the
major primary sector banks, and the Bank therefore organized a
"lifeboat" of clearing banks to provide liquidity for secondary banks
suffering runs. In most cases the risk of loss was borne by the
clearing banks, although the Bank agreed to cover losses over the
exposure limits, thereby exposing itself to significant risk as well.
In the end, several of the banks failed, and the Bank bore losses
under agreed-upon indemnities, even though significant recoveries
were made over subsequent years as some of the failed banks' loans
were repaid or sold.
Another example of the Bank as organizer of a bank rescue occurred in
1984 in the case of JMB, a major participant in gold bullion and
commodity trading and one of the five London gold price fixers. As a
result of large exposures that it failed to report to the Bank, JMB's
capital was all but eradicated. The Bank feared for London's
position as the leading international gold bullion market and, after
the JMB parent company could not provide enough capital to save the
bank and potential purchasers who were approached by the Bank
withdrew, the Bank itself provided support for JMB. After
considerable pressure from the Bank, the four London clearing banks\3
agreed to provide �35 million; the members of the gold market, �30
million; and the other members of the accepting houses committee, �10
million to support JMB. Neither the Bank nor any of the
participating banks bore any losses in the JMB rescue.
Since the establishment of the Deposit Protection Fund in 1979, which
limits the losses of small depositors, banks might be less inclined
to participate in rescue attempts on the scale of the early 1970s,
according to a Bank official. Nevertheless, in 1991, the Bank
provided an indemnity to support a �200 million liquidity facility
provided by a group of large U.K. banks to the banking subsidiary of
a major mortgage lender and subsequently took over the direct
funding. In 1994, the Bank acquired the mortgage lender and its
subsidiaries for a nominal consideration.
--------------------
\3 Barclays, Lloyds, Midland, and National Westminster.
PAYMENTS CLEARANCE
-------------------------------------------------------- Chapter 4:2.3
The Association for Payment Clearing Services (APACS), the umbrella
organization for the privately owned clearing systems in the United
Kingdom, is responsible for the provision and development of payment
clearing mechanisms in the United Kingdom and for overseeing
developments in payment systems\4 generally. This means running the
clearings for checks and paper credit transfers as well as for
electronic debits and credits together with the systems that handle
high-value transfers in the United Kingdom.
The Bank acts as settlement institution for members of the three
sterling payment systems but does not, itself, own or operate any of
these systems.\5 It is, however, a member of APACS and of the
individual clearing companies with the right to appoint a director to
the board of each of the clearing companies. Consequently, the Bank
has a voice in APACS decisions, and its special interest is generally
recognized on questions of public policy.
There is no statutory supervision or regulation of the payment
systems operating in the United Kingdom, though the Bank has implicit
responsibility for oversight of the payment systems by virtue of its
core responsibilities as a central bank. As such, it aims to ensure
that they are reliable, efficient, and, as far as possible,
risk-free.
The Bank is currently working with APACS to develop the Clearing
House Automated Payment System into a real-time gross settlement
system.\6 The Bank hopes to begin phasing this system in by the end
of 1995.
--------------------
\4 A payment system is a financial system that creates a mechanism
for transferring money between suppliers and users of funds.
\5 The three sterling payment systems are (1) for the settlement of
transactions in government securities, (2) money market instruments,
and (3) ECU denominated securities.
\6 Real-time gross settlement means that all transactions in an
electronic payments system are settled immediately in full, usually
with a transfer of central bank balances.
PARTICIPATION IN
INTERNATIONAL ORGANIZATIONS
-------------------------------------------------------- Chapter 4:2.4
The Bank participates in developing U.K. positions with respect to
several international organizations even though it takes the lead
only on the Basle Committee on Bank Supervision, whose primary
purpose is addressing bank supervision-related issues, and on the
Banking Advisory Committee of the EU. In both of these cases,
Supervision and Surveillance represents the Bank. In other groups,
such as the European Union Council of Ministers and the Organization
for Economic Cooperation and Development, the Bank provides
assistance to the Treasury or other government agencies in developing
positions, and Bank staff may attend meetings. The SIB, as the
regulator of U.K. securities firms, is the U.K. representative to
the International Organization of Securities Commissions.
LENDER OF LAST RESORT
-------------------------------------------------------- Chapter 4:2.5
The Bank continues to act as lender of last resort to the banking
system, a role almost as old as the Bank itself. According to the
Bank, its responsibility consists of supporting banks whose failure
would initiate a loss of confidence in the U.K. financial system as
a whole. The Bank admits that size is an important factor in
considering systemic effects, but that no bank should consider Bank
assistance automatic or without penalty. Furthermore, before
committing its own funds, the Bank will encourage a bank to find a
buyer, attempt to persuade bank creditors to provide support to
protect their own positions, or try to find a group of banks with an
interest in an orderly resolution. If all else fails, the Bank may
consider committing its own funds, but only if the bank's problem is
one of liquidity, not of solvency. Nevertheless, the Bank does not
mandate that its lending be collateralized.
At the time of any lender of last resort action, the lending is
generally not made public, although the Bank will obtain the
Treasury's approval for the proposed action. The lending is also
generally made without a government guarantee, and the deposit
protection system does not play a role in providing or guaranteeing
funds. This means that the Bank is subject to losses if banks to
which it has lent money on an uncollateralized basis are unable to
repay the funds.
The most recent example of lender of last resort action made public
by the Bank was when it provided liquidity support to a few small
banks in 1991. During 1990 and 1991, a number of small banks had
experienced difficulties due to the depressed real estate market and
increasing defaults on consumer credit. The resulting failure of
several smaller banks and the closing of BCCI in 1991 contributed to
the small bank sector's experiencing wholesale funding difficulties
as local authorities and public corporations in particular withdrew
deposits on maturity. In order to avert a possible systemic
disturbance that could result from multiple small bank failures, the
Bank provided liquidity support with the government's knowledge, but
without a government guarantee. As a result of its lending to small
banks in 1991, the Bank made provisions in 1993 of �115 million
against possible losses from the failure of some of these banks,
although exact losses have not been published. If any of these banks
were to fail and losses were to ensue, the Bank would be treated as
an unsecured creditor and would participate in distributions by a
liquidator. It would not receive any funding from the Deposit
Protection Fund.
PURPOSE AND STRUCTURE OF THE BANK
OF ENGLAND
=========================================================== Appendix I
According to the Bank of England's (the Bank) annual report and
accounts, the Bank's "core purposes, as the central bank of the
United Kingdom, are to maintain the integrity and the value of the
currency (monetary stability) and the integrity of the financial
system (financial stability)." Related to the goal of financial
stability is the promotion of "the efficiency of [the U.K.'s] key
financial markets."\1
The Bank is subordinate to the government when determining monetary
policy, although it has been granted a greater degree of independence
in recent years. Monetary policy is still dictated by the Treasury,
after consultation with the Bank, but the Bank has been given some
flexibility in determining how to attain these monetary goals and may
publish its own recommendation on monetary policy.
In July 1994, the Bank underwent a management restructuring that
consolidated numerous divisions into two wings: the monetary
stability wing and the financial stability wing. This restructuring
was intended to emphasize the core purposes of the Bank, as described
above. (See fig. I.1.)
The monetary stability wing extends from economic and monetary
analysis (covering the United Kingdom and overseas), through the
preparation of the Bank's monetary policy advice and the Inflation
Report, to the implementation of monetary policy in the markets and
to the banking services that support the Bank's policy operations.
The financial stability wing brings together the Bank's statutory and
nonstatutory supervision work, together with surveillance of markets
and overseas financial systems; work on payment, settlement and
clearing systems; and the Bank's nonstatutory interest in the
stability of the whole of the financial system; the efficiency and
competitiveness of the U.K. financial sector; the CREST securities
settlement system project;\2 and finance for industry.
Figure I.1: Management
Structure at the Bank
(See figure in printed
edition.)
Source: The Bank of England.
(See figure in printed
edition.)
--------------------
\1 The 1946 Act makes no direct reference to monetary policy or the
Bank's role in it, or to maintaining financial stability.
\2 At the proposal of the Stock Exchange, in March 1993, the Bank
established a Securities Settlement Task Force to make proposals on
an improved equity settlements system in the United Kingdom. The
replacement settlements system is known as CREST.
QUESTIONS OF POTENTIAL CONFLICTS
OF INTEREST BETWEEN THE BANK OF
ENGLAND'S ROLE AS MONETARY
AUTHORITY AND BANK SUPERVISOR
========================================================== Appendix II
Questions have been raised recently in the United Kingdom about
possible conflicts of interest when a central bank combines the role
of central monetary authority and bank supervisor. While the Bank
acknowledges that potential conflicts exist, it is the Bank's
position that such potential conflicts are not severe and would exist
whether or not the two functions are under the same roof.
Furthermore, the Bank believes that any potential conflicts are
easier to resolve within an institution, rather than between two, and
that there are synergies involved in combining monetary authority and
bank supervision under one roof that outweigh the potential
conflicts.
POTENTIAL CONFLICTS OF INTEREST
-------------------------------------------------------- Appendix II:1
The Bank acknowledges that a number of potential conflicts could in
theory exist when the responsibilities of the central monetary
authority and bank supervisor are combined under one roof. The
potential conflict that has raised the greatest concern is that the
central bank that also supervises banks may compromise on the conduct
of monetary policy if it believes that the financial viability of one
or more banks or systemic stability might be at stake. It is
possible, for example, that a central bank might keep interest rates
artificially low for a period of time--to the detriment of monetary
policy goals--in order to help banks contain problems in their loan
portfolios that might be aggravated if interest rates were raised.
According to a senior Bank official, critics of combined monetary and
bank supervisory responsibilities have also raised a number of other
concerns. These critics believe that
-- there is a potential conflict between the Bank's role as
ultimate supplier of liquidity to an institution in difficulty
and its role as supervisor,
-- the knowledge that a central bank obtains as bank supervisor can
give it an unfair competitive advantage when it competes with
other financial institutions, for example, when it is acting as
principal or agent in its banking operations, and
-- the central bank's reputation may be damaged by supervisory
failures and consequently compromise its ability to conduct
monetary policy.
THE BANK AGREES THAT THE
POTENTIAL FOR CONFLICTS EXISTS
BUT MAINTAINS THAT SYNERGIES OF
COMBINED CENTRAL BANK AND
SUPERVISORY RESPONSIBILITIES
OUTWEIGH IT
-------------------------------------------------------- Appendix II:2
Bank officials acknowledge that some of these concerns may be valid,
but argue that they are overstated and do not take into consideration
the outweighing synergies associated with a combined central bank and
bank supervisor. With respect to the tension that exists between
monetary policy and bank supervision, the Bank contends that such a
tension can exist whether or not bank supervision and monetary
responsibilities are placed within the same institution.
Furthermore, it believes that the conflicts that do develop are rare,
because the monetary stability and financial stability wings of the
Bank have similar objectives, and that conflicts are more easily
coordinated and priorities more easily developed when these
responsibilities are housed under one roof.
In addition, the Bank argues that the conduct of monetary policy can
be frustrated if the financial system is unstable and that the
central bank, therefore, has a very intense interest in ensuring the
soundness of the banking system and consequently a need to be
involved in bank supervision and related areas such as oversight of
the payments system. It believes that the Bank must "put itself in a
position to anticipate and judge how it should deal with any
weaknesses in the infrastructure or institutions on which it relies
for the conduct of monetary policy." While it acknowledges that it
can obtain information from a separate supervisor, it believes that
it is more efficient if that information is available to it as the
bank supervisor. It also believes that arguments to the contrary are
not strong enough to justify placing its current supervisory
responsibilities in a new bank supervisor.
The Bank also believes that there is no unmanageable conflict between
the roles of the central bank as lender of last resort and supervisor
of banks. Indeed, it believes that a decision on whether to provide
such lending "is made less difficult if the central bank also has the
information customarily obtained from conducting supervision." It
further argues that the possibility of having to provide lender of
last resort liquidity to an institution serves to focus bank
supervision.
With respect to arguments that the information the central bank
receives as bank supervisor may be misused, the Bank contends that it
has arrangements in place "to ensure that information, when received
for supervisory purposes, is not abused or misused" and that
procedures are in place to ensure that senior and qualified people
"can strike the correct ethical and legal balance."
Finally, the Bank does accept that supervisory failures may damage
the authority of the central bank. However, it believes that such
potential damage may be overblown and that the worst impact is "the
diversion of time and energy when supervisory problems demand,
particularly if they occur at a time when issues of monetary policy
are themselves problematic."
REGULATION AND SUPERVISION OF
BUILDING SOCIETIES
========================================================= Appendix III
Building societies are mutual deposit-taking institutions that lend
predominantly for house purchases. Only 25 percent of their assets
may be in commercial or unsecured lending. Furthermore, they have
liquidity limits of 33 percent of total assets since their primary
purpose is to lend their funds.
As of October 31, 1994, there were 83 building societies authorized
to take deposits, of which the top 10 held some 80 percent of the
industry's assets. While the number of building societies continues
to drop from a high of approximately 2,500 at the turn of the
century, the assets in the industry are rising, increasing to �280
billion in 1994 from �160 billion in 1988.
Building societies are regulated and supervised by the Building
Societies Commission, rather than by the Bank, under the Building
Societies Act of 1986.\1 This act extended building societies' powers
to undertake some additional activities besides mortgage lending.
The Building Societies Commission is an independent body set up by
the 1986 Act and is currently made up of seven Commissioners. During
the fiscal year the Commission met 17 times.\2 The Commission's
activities are funded by money voted by Parliament, which is met by a
charge levied on the societies. At the end of the March 31, 1994,
fiscal year, the Commission had 59 staff.
According to the Commission's annual report, its functions are to
(1) ensure that the principal purpose of building societies remains
that of raising, primarily from their members, funds for making
advances to members secured by land for their residential use;
(2) promote the protection by each building society of the
investments of its shareholders and depositors;
(3) promote the financial stability of building societies generally;
(4) administer the system of regulation of building societies
provided for, by, or under, the act; and
(5) advise and make recommendations to government on any matter
relating to building societies.
In addition, the Commission is responsible for authorizing new
societies, although applications for authorization are rare. The
last new building society was authorized in 1981.
--------------------
\1 Before 1986 building societies were regulated by the Registry of
Friendly Societies. The Registry is a nonministerial government
department for which Treasury ministers answer in Parliament.
\2 The fiscal year runs from April 1, 1993, to March 31, 1994.
REGULATION
----------------------------------------------------- Appendix III:0.1
The Commission's mandate under the 1986 Act is to "administer the
system of regulation set out by, or under, the act." Included in the
act are criteria of prudent management, which are the basis for the
Commission's regulatory powers.
The Commission undertakes regulation in a number of ways. First, the
Commission has the power to make secondary legislation, subject to
the approval of Parliament. It uses this power to fine-tune the
primary legislation relating to building societies, the 1986 Act.
During the March 31, 1994, fiscal year, the Commission made seven
such statutory instruments, while the Treasury made four following
advice from the Commission. Since 1986, 109 statutory instruments
have been made under the act, of which 59 are currently in force.
The Commission also produces regular prudential and policy guidance
and advice to building societies. It does this primarily through
(1)Prudential Notes whose purpose is to set out and explain what, in
the opinion of the Commission, is needed for a society to meet the
criteria of prudent management set out in the act;
(2)Guidance Notes that usually explain statutory or administrative
procedures; and
(3)"Dear Chief Executive" letters that cover a wide range of
communications to societies.
Prudential and Guidance Notes are issued first as drafts for comment
to the industry and other interested parties. During the March 31,
1994, fiscal year, the Commission issued 5 prudential notes and 21
Dear Chief Executive letters.
SUPERVISION AND ENFORCEMENT
----------------------------------------------------- Appendix III:0.2
The Commission receives supervisory information on the building
societies in a number of ways. First, the Commission requires
statistical returns from the building societies, some monthly, some
quarterly, and some annually. These returns are used to establish
the continuing financial health of the institutions.
Second, the Commission's staff is expected to maintain close contact
with the societies. It held about 400 regular meetings with the
societies over the March 31, 1994, fiscal year. These meetings are
intended to ensure that societies are fully and properly informed of
the Commission's prudential guidance and that the Commission
appreciates the business and the concerns of each society. These
meetings include an annual meeting between each society and the
Commission, which will be attended by the Board as well as senior
management and will often be chaired by a Commissioner. At these
meetings, the discussion is to include what has happened to the
building society over the past year and what its plans are for the
next year or two. This is to be followed by a report from the
Supervisor to the Commission.
Third, the Building Societies Act requires that building societies
have annual financial audits and that the Commission also receive
systems reports from the societies and their external auditors, which
provides information on the societies' systems and controls. The
Commission does not set the scope of building society audits, and it
has no codified list of what the auditors should do. Furthermore,
the Commission does not have the power to require a building society
to change its auditor nor does it have a list of approved auditors.
The Commission will take up any issues it feels necessary with the
building societies, their auditors, or both on an as-needed basis.
Such discussions would be triggered by the annual report of the
society's supervisor to the Commission.
The Commission does not have its own inspection branch, although it
does have a wide range of experience and expertise among its
supervisors to look at problem situations in societies. However, if
the situation were complicated, the Commission would employ outside
accountants to undertake the examination. This power has been used
only three times since enactment of the 1986 Act. Very often just
the suggestion of such an audit will convince a building society to
take the necessary action.
According to the Commission's annual report, "the Commission aims to
achieve its supervisory objectives by discussion and persuasion, but
as a last resort, may use its powers of control set out in the 1986
Act." These powers include (1) imposing conditions on or revoking a
society's authorization, (2) obtaining information from a society, or
(3) appointing investigators. The Commission may also require a
society to increase its capital levels. During the March 31, 1993,
fiscal year, it did not use any of its formal powers except to
automatically revoke authorization following a merger.
DEPOSIT PROTECTION
----------------------------------------------------- Appendix III:0.3
The 1986 Act provided for the establishment of the Building Societies
Investor Protection Fund (the Fund) from which payment would be made
to investors in a society that became insolvent, and an Investor
Protection Board (the Board) to hold and manage that Fund. The
Investor Protection scheme protects to a maximum of 90 percent the
first �20,000 of a person's shares and/or deposits. The Fund is
financed by contributions levied on each society up to a current
maximum of 0.3 percent of its share and deposit base.
The Board has seven members including three representatives of the
building society industry. An additional three of the Board's
members are members of the Building Societies Commission. The
Chairman of the Board is, ex officio, the Chairman of the Building
Societies Commission and the Deputy Chairman is, ex officio, the
Deputy Chairman of the Commission. The Board's seventh member is the
chief cashier of the Bank and a member of the Deposit Protection
Board.
The Board met only once in the March 31, 1994, fiscal year and has
not yet been called on to make any insolvency payments.
MAJOR CONTRIBUTORS TO THIS REPORT
========================================================== Appendix IV
GENERAL GOVERNMENT DIVISION,
WASHINGTON, D.C.
-------------------------------------------------------- Appendix IV:1
Tamara E. Cross, Evaluator
Hazel Bailey, Writer-Editor
Phoebe A. Jones, Secretary
EUROPEAN OFFICE
-------------------------------------------------------- Appendix IV:2
Maja C. Wessels, Evaluator-in-Charge
OFFICE OF GENERAL COUNSEL,
WASHINGTON, D.C.
-------------------------------------------------------- Appendix IV:3
Paul G. Thompson, Attorney
*** End of document. ***